Negative Equity: Heartache for Home Owners

Kenneth Harney laments in his piece published in the San Jose Mercury News that, once upon a time, people actually made "sizable" down payments on houses they bought.  The statistics he quotes are downright scary: almost 50% of all first-time home buyers financed 100% of the transaction.

Image of Upside Down Car

That's right, half of all new home buyers put zero percent down.

How much should they have allocated as a down payment?  In a period where there seemed to be no limit to the price of single-family homes, or bounds to lending practices, it's easy to understand how people got carried away.

After all, every infomercial personality worth his salt was talking about cash-on-cash return and buying properties with no money down.

Now that we've seen the sequel to the movie "Buying on Margin" which bankrupted more than a few daytraders at the turn of the century, we need to talk about the concept of "negative equity."

Upside-Down Is Not a Fun Place to Be

Imagine selling your house and still owing money on your mortgage.  That is what it means to have negative equity: the debt you own on your property exceeds your property's value.  In industry parlance, it's called being "upside-down" and Liz Pulliam Weston at MSN Money says 1 in 10 homeowners may be in this situation!

When this happens, the normal thing to do is wait.  If you don't have to sell the property and you're still using it, then the equity value you have in the house isn't as important as your ability to live in it.

Dealing With the Short Squeeze

But if you've purchased a house with an adjustable rate mortgage (ARM), you may have a rate reset coming up that will cause your payments to increase.  If you believe they'll increase to levels you can't afford, then you can always refinance, right?

Maybe. 

There are prepayment penalties to consider which may put you in more debt if you decide to refinance.  Also, since refinancing is another test of your credit's ability to secure you a loan, your FICO score and debt-to-income ratio come back into play just as if you were figuring out how much house you could afford to begin with.

Take Action If You're There

You don't have to lose your house, but you will need to take the important steps of decreasing your debt and spending.  Get your credit back on track and read important tips on becoming more frugal.  This will allow you to save money and buy you time to get out of a bad situation.

Try reading these great sites on personal finance: