Image: Mike Choi
Sean D. Elliot for msnbc.com for
Mike Choi's townhouse in Connecticut has two bedrooms. But he lives in the basement, renting out the upstairs rooms to help pay down his lost equity.
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msnbc.com contributor
updated 9/13/2010 3:53:41 PM ET 2010-09-13T19:53:41

When Mike Choi, an engineer living in the New London, Conn., area, bought a three-level townhouse in 2004 for $183,000, he wasn’t worried about the real estate market.

He was 24, had a good engineering job, and could easily afford monthly payments on the mortgage he took out with no down payment. But six years later, his home’s value has fallen to the low $150,000s. Choi, now 29 and with an MBA, feels restricted in his job hunting because moving elsewhere would force him to sell his home for less than he owes on it.

So he is doing what millions of Americans are doing these days: He’s getting used to living life “underwater” — the real estate industry’s term for a property worth less than the outstanding mortgage on it.

A broad swath of homeowners who have been able to avoid the worst-case scenario of foreclosure are nonetheless grappling with the impacts of lost home equity. Living underwater presents a new set of challenges, like not being able to tap home equity to fund a child’s college tuition or having to wonder whether the cost of home improvements like a remodeled kitchen can ever be recouped.

For these owners, seemingly unscathed by the housing crisis, it’s hard to complain aloud about making such minor adjustments when so many homeowners have lost homes, gone deep into debt, or faced the moral dilemma of whether to walk away from a home worth a fraction of its purchase price. But still, most home buyers just didn’t count on falling home values when they bought.

Americans have become intimately familiar with what can happen when declining home values collide with other unforeseen circumstances like losing a job or a medical emergency: They’ve seen unprecedented foreclosures, owners walking away from mortgages, headlines about owners’ struggles to modify mortgages and a rise in short sales, where the house is sold at a loss, often leaving the seller to make up the difference to the lender.

'It's good to have a mortgage'
“When I bought I was young and naïve and I had listened to my peers. They said ‘It’s good to have a mortgage,’” Choi says. “In one sense I have regrets, which is that this house is tying me down.”

Choi's zero-down mortgage was structured in two parts—a loan for 20 percent of the home’s price carrying an 8.375 percent interest rate, and a loan for 80 percent of the purchase price carrying a more-affordable 6.125 percent interest rate. Once his home’s value fell, Choi couldn’t refinance his mortgage to more favorable terms because his loan to value ratio was too large. He was ineligible for government modification because he earned too much.

So Choi is renting out his two bedrooms and using the rental income to whack away at the higher-interest component of his mortgage and regain some equity. He estimates he’ll have the 20 percent mortgage paid off by February 2012.

“It wasn’t like I woke up one day and said, ‘Oh no! My house value dropped $30,000,’” he says. “My situation isn’t that bad. I have a good job, and I’ve kept a good credit score.”

But he acknowledges he’s had to get creative to work around what’s happened in the market. He sleeps in his basement so his renters can use the two bedrooms in the upstairs portion of his 1,500-square-foot townhome. He jokes about whether his subterranean living space might be why he’s single.

According to real estate data website Zillow, 21.5 percent of the nation's single-family homes with a mortgage were underwater or had “negative equity” at the end of the second quarter 2010. Some markets (Phoenix’s 66.8 percent, Miami’s 44 percent, Minneapolis-St. Paul’s 36 percent) clearly are showing more stress than others. Zillow estimates 60 percent of all U.S. homes are mortgaged, with the rest owned outright.

While the negative equity rate is beginning to fall — it was 23.3 percent at the end of first quarter — Zillow chief economist Stan Humphries said the improvement may reflect homebuyer tax credits that were in effect during the first half of the year. He called the end of the credits a “large unknown,” however.

“Recent trends in home values suggest the nation could reach a bottom in the latter half of 2010,” Humphries said in a statement. “We continue to be cautious about the impact of declining home sales."

Life Inc.: Home price rebound? Not exactly

Others who have been through a short sale and still have debt to repay find themselves working overtime to work it down. People like Elizabeth Moore, a 36-year old graphic design consultant, and her husband, a doctor.

'We're not the walk-away types'
The couple lost money on a home they bought in 2004 and sold earlier this year in the Gulf Coast region.

They didn’t have much choice in the matter: They had moved in 2007 to South Carolina so Moore’s husband could take a better job. They wound up renting out their property at a loss for several years before deciding to sell it in the wake of several notorious hurricane seasons. They’re now paying a mortgage on their home in South Carolina while also repaying $80,000 in debt connected to losses on their former home. A financial planner advised bankruptcy, but Moore says she and her husband feel morally obliged to repay their debt.

“We’re not the walk-away types,” Moore says. “We’re the types who want to own our home and pay the mortgage and fulfill our obligations.”

The ramifications, however, have been stressful. The Moores have deferred some of their tax bills, and both Moore and her husband are working onerous hours: He’s working extra shifts, while Moore is using freelance work to get her own venture off the ground.

“We’ve just had to scramble with a lot of this stuff,” she says. “It’s been a lot of work. My husband is really tired.”

For now, there is no end in sight to this lifestyle, she says. But she is not resentful, and sees the situation as beyond their control — the sum of relocation, weather and broader economic trends.

“You get yourself into this,” she says. “And you get yourself out of it.”

American Dream redefined
Choi also said he would own again in the future, but recent research suggests that the prolonged housing downturn and thus-far tepid recovery are eating away at Americans’ bullishness on homeownership.

A survey released by Zillow last month shows that 28 percent of homeowners believe real estate values in their local markets will fall over the next six months and 30 percent don’t believe values will rise. This indicates “increasing pessimism” about housing, the company said, pointing out that only 24 percent of homeowners said they thought their home had risen in value during second quarter when, in fact, 34 percent of homes rose in value.

Other research agrees. The percentage of adults who hold a “core belief in the inherent value of owning a home” has fallen from 77 percent six months ago to 72 percent as of July, according to a survey from San Francisco-based Trulia and Harris Interactive.

Among renters, 27 percent don’t ever intend to buy, while among those considering buying 68 percent intend to wait at least two years.

“The majority of Americans still think homeownership is part of the American Dream,” said Pete Flint, CEO of Trulia.

However, he adds, they also want to apply “realism” to their view of the market. Part of that, he said, is reflected in a strong desire to have a large down payment before buying. While lenders are asking for higher down payments now, many consumers are also volunteering or planning to pay more up front to protect themselves from a volatile market.

“Consumers are realizing they don’t want to get into a negative equity situation,” he says.

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Data: Latest rates in the US

Home equity rates View rates in your area
Home equity type Today +/- Chart
$30K HELOC FICO 4.65%
$30K home equity loan FICO 4.97%
$75K home equity loan FICO 4.33%
Credit card rates View more rates
Card type Today +/- Last Week
Low Interest Cards 11.22%
11.09%
Cash Back Cards 16.46%
16.42%
Rewards Cards 16.10%
16.04%
Source: Bankrate.com