Disappearing equity

03.03.09
By John Ulzheimer

Until about two years ago Americans, including lenders, operated under the assumption that the value of homes and real estate would continue to appreciate. Given what has transpired over the past six months, I believe we’ve all learned a valuable and painful lesson: We were all wrong. And while we can point to many examples of painful fallout from the mortgage meltdown, perhaps the most significant is the reduced value of our largest single investment: our homes.  

The estimates are inconsistent, but it’s safe to say that we’ve collectively lost over 1 trillion dollars of value in our homes over the past two years. While it’s a monumental disaster already, many people – including me – believe that we’re not even close to out of the woods yet. I believe home values will continue to drop, which means we’ll continue to lose true equity and experience an increasing amount of negative equity.

Equity, of course, is the value of an asset, such as a home, above what you actually owe on it. For example, if I own a home that’s worth $100,000 and I owe $80,000 on that house, then I have $20,000 of equity. A better example, one that’s more appropriate in today’s credit environment, would be a home worth $80,000 where you owe $100,000. In this example, you would have $20,000 of negative equity.

It’s no secret that determining value, and therefore equity, is an inexact science. A licensed appraiser will inspect your house and then investigate sales of comparable homes in your area. This common method has come under fire in recent years. One criticism, which I agree with, is that the value of a home has to be determined by more than just what other homes, none of which you owned or cared for, have sold for. Who knows why the buyer and seller agreed on their final price? Perhaps the seller was desperate. Perhaps the buyer doesn’t like to negotiate and pays sticker price for everything. Regardless of the situation, the final price shouldn’t have so much weight on the perceived value of your home. It’s my opinion that a home, and anything else for that matter, is worth whatever someone is willing to pay for it.

So, home equity can decrease with market downturns, and it’s unpredictable to begin with due to the inexact nature of appraisals. The best thing to do if you own a home in these turbulent economic times is to keep up with your mortgage payments. Even if you find yourself with little or no equity in your home, find solace in the fact that this downward swing of the market is just that – a swing – and it will go back up again someday.

Thursday we will visit the topic of HELOCs (Home Equity Lines of Credit) and their impact on credit scoring models. This will be another article in my myth-buster series.

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The value of a home has to be determined by more than just what other homes have sold for.