American Home Values Heading into Deeper Waters

Home values are still sliding, and the trend is sending more and more homeowners into negative home equity territory.

In 1975, moviegoers chuckled when Mayor Larry Vaughn in Jaws claimed that the shark scare was "all psychological." But today, no one laughs when yet another report reveals that unrealized losses are continuing to pile up for homeowners.

Amazing, disappearing wealth

Last month, the S&P/Cash-Shiller Home Price Index confirmed that housing prices fell substantially in the third quarter, following a record decline in the prior three-month period. More recently, a Zillow.com report concluded that home values have dropped 8.4 percent during the first nine months of 2008. That same report also estimated that the cumulative housing value lost this year could reach $2 trillion by year-end.  

That's $2 trillion of household wealth-gone.

Rock and a hard place

Given everything else that's happening in this economy, disappearing home equity is tragic news for homeowners. Already, it's estimated that more than 11 million homeowners nationwide are underwater on their mortgage loans-underwater meaning that the borrower's mortgage balance exceeds the value of the mortgaged property. In that situation, the borrower can't sell or refinance without putting up enough cash to bridge the gap between the loan balance and the home's value. And every time the mortgage statement arrives in the mail, the borrower must accept the reality of paying more for the property than it's worth. If the payments are already burdensome, some borrowers actually choose to walk away and let the lender foreclose. As home values continue to slide, more homeowners will undoubtedly consider that option.

No light in this tunnel

There was a time when experts, including Treasury Secretary Henry Paulson, said that the housing crisis had largely run its course. In recent months, those optimistic predictions have all but disappeared. Now, the expert consensus is that housing problems will get worse before they get better, as the recession and rising unemployment take their toll on homeowners and prospective home buyers.

At this point, it's impossible to predict the impact unemployment may have. In November, the number of unemployed workers in the U.S. increased by 251,000 following an October increase of 603,000. Some experts, including the chief economist at IHS Global Insight, believe that the unemployment rate could rise another 2 points, to 9 percent, by the end of 2009. Undoubtedly, that means that more homeowners will find themselves struggling to make mortgage payments.

Even homeowners who aren't yet underwater or unemployed will face more limited financial flexibility if home prices weaken further. Shrinking home equity dissolves the borrowing power that formerly funded college educations, home repairs, and debt consolidation.

Home value declines are technically unrealized losses until the property is sold. But the impact on homeowners is both tangible and psychological. As housing prices head further into deeper waters, even the calmest homeowners may be nervous about swimming with sharks.