How this turns your house “upside down”
What are the consequences of your house’s decline in value? Chances are, many homeowners have fallen into a debt trap; and the most drastic effect is seen when the homeowner suffers from negative equity. Before mortgage default is approved, a borrower must first have his outstanding mortgage balance higher than the property value, less selling costs, or more commonly known as negative equity. This is the result of paying a very low or no down payment or taking the wrong type of loan. All are made worse by an economic downturn.
According to data expert First American CoreLogic, 15.2 million Americans are in negative equity. In Memphis, TN, 43.08 percent of mortgages are “upside down”– 10 percentage points higher than the country’s 32.2 percent June record.
Negative equity is more damaging to credit when a homeowner’s obtains a second loan and can’t continue to repay the balance of his debt. Mortgage default in the first loan make it impossible for the borrower to pay back debt since the property may be repossessed by the lender. Remember, however, that unless the house is for sale or there is a need to withdraw equity, homeowners will never realize the consequences of negative equity. That’s why if you pay no down payment and have the house sold immediately, you can never recoup your loss because you already have negative equity plus the cost of the additional transaction.
A comprehensive paper by Foote, Gerardi and Willen entitled “Negative Equity and Foreclosure: Theory and Evidence” concludes that.“… policy responses need not, and probably cannot, address the negative equity problem directly. Instead, these policies should focus on lowering current mortgage payments in order to make default less attractive to the borrower. Forbearance programs that allow borrowers to delay, but not to avoid eventually repaying the mortgage in full can help at-risk borrowers without generating serious moral hazard problems, involving assistance, funded at the public’s expense, to those who do not need it.”
Therefore, the surest way to get out of this situation is for the homeowner to begin building positive equity until it reaches the zero-equity level. A second job, perhaps?… The borrower must also have faith that the situation resolves through normal market forces – that is, the property market rebounds and home values begin to appreciate.
Here are three parts of a debate from RTE One concerning negative equity: