This week we received great news in the employment numbers but also discouraging numbers on the housing front.  Prices were down and negative equity up.  Zillow, the online real estate valuation website, came out with numbers that had gloom and doom written all over them.  28% of homeowners with mortgages owe more than their home is worth.  This reality naturally varies from market to market because in some cities that number approaches 75%.  This is called negative equity – the opposite of having equity in your home.  The problem with a negative position is that a borrower is paying towards a mortgage, but not building equity.  Think of it like buying a car.  The moment you drive the car off the lot, it drops in value and you owe more than the car is worth.  Eventually you’ll pay off the car, but for the first several years, you can’t sell it unless you put some additional money in to pay off the loan.  What’s interesting to me is that people seldom walk away from their car or have it repossessed. Yet, there has been a lot of talk about “strategic defaults”, where homeowners throw their hands up in the face of declining property values, and simply walk away from the home, its debt and then begin the arduous task of starting over.  So why is this happening with homes and not cars?

To begin, most of us need a car.  But don’t we also need a roof over our heads too?  Because of this, strategic defaults are not nearly as common as the media would have you believe.  Furthermore, homeowners have an option to sell the home short of what is owed (with lender approval) called a “short sale”.  But what about our national psyche and the effect of negative equity on our confidence? Without question we are suffering from lack of confidence in buying a home.  Why else would people not be buying like crazy right now with low interest rates, home values down to 2003 levels and lower, if not for lack of confidence?  So here is the discussion I believe we need to be having: how much does it save to walk away and rent rather than to pay towards an underwater mortgage?

Consider that with renting there is no deduction for property taxes and interest.  So for argument sake, let’s assume a property owner’s total cost of ownership (not including maintenance and utilities) is $4,000 a month, and that to rent a comparable home is $2,500.  After the write off of the taxes and interest at a .28% tax rate, the homeowner writes off $1,120 (.28 x $4,000).  But that might include principle and insurance, so let’s round that figure down to $800 in income tax savings.  If we use these numbers, the total cost is $3,200 a month to own vs. $2,500 to rent.  This means for the owner to save their credit and keep their family home, they have to pay $700 more every month ($8,400 per year), than renting.  Of course there’s the  additional cost of ownership in gardening, and repair too, but the actual cost of paying an “under water” mortgage isn’t nearly as high as you might expect.  Then there is the whole social cost to a society where personal responsibility the cast aside in favor of financial gain, (we can talk about this behavior in Corporate America and Wall Street another time).

In the end, each borrower must assess their situation and answer to their own conscience, but while it’s depressing for sure, when you look at the numbers, negative equity is not as big a deal as you might think, and the lack of confidence in real estate not justified.