Pay and Pray

This story from Inman News is appropriate for a Sunday, as millions of Americans seek to bolster their faith in what they know to be good and true - home equity. As many have come to find out in 2006, there are two very different types of home equity - positive (the good kind) and negative (the bad kind).

Here's an example of the bad kind:

"I work for a company that is on the decline, so I decided it was prudent to seek employment in another area. I have accepted a position elsewhere but now face a problem. I owe about $20,000 more on my current home than what it can sell for due to declining market values in my area, and I don't have the assets to make up that difference."

When you sell your house, you must pay off all liens on it — all mortgages including home equity lines of credit and any tax or mechanic's liens. If you don't retire all existing liens, you can't convey good title to a buyer, which means you can't sell.

You cannot escape this trap by transferring an existing lien to another property. Liens apply to a particular property and can't be transferred to another one without the permission of the lender, which is not going to happen.

Since the letter writer can't buy a new house unless he can sell his old one, his only recourse is to re-enter the rental market — as a tenant in the new area and as a landlord in the old one.

Negative equity can develop from a decline in local real estate values, as it did in the case of the letter writer, but that is not the only cause.

Home buyers who make no down payment have negative equity when they move in. And if they had to sell immediately, they could not repay the loans out of the sales proceeds because of the transaction costs. The sales commission alone runs 3% to 6% of the price. Most home buyers realize this but expect that price appreciation will bail them out, which doesn't always occur.

Lenders are supposed to be more worldly and wiser, but in fact, they are caught up with the expectation of appreciation just as much as borrowers are.

What can a borrower with negative equity do? Not much. You hunker down, pay your mortgage on time, pray that nothing happens that will force you to move and wait for appreciation.

And what if that doesn't happen?

Then you may be forced to build equity the old-fashioned way: by paying down your mortgage.

That last line is a classic - building home equity the old-fashioned way.

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A long-dormant subscription to BusinessWeek was recently reinstated as the rates have become ridiculously low. As is the case this week when the latest issue of The Economist fails to arrive over the weekend, it can come in handy.