Homeowner equity is property value less the sum of all debts secured by the property. If equity is negative, it means that the debts exceed the property value.

Homeowners who think of themselves as tenants may not be much bothered by negative equity. As long as they make their monthly payments, they can continue to live in the house, just as if they were tenants. But homeowners with a homeowner — rather than a tenant — mentality are looking to a future in which they build equity. For them, negative equity is a psychic burden until they rid themselves of it, and it can turn into a curse.

The psychic burden comes from knowing that the portion of their mortgage payments that goes to principal only serves to reduce the amount of their negative equity. They can’t start building positive equity until they cross the zero-equity threshold. Negative equity can turn into a curse if something happens unexpectedly that requires that the property be sold. Here is an example:

“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 the house — all mortgages including HELOCs, 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. Hardly a week goes by that some homeowner with negative equity does not ask me whether, in selling his/her house, the second mortgage can be transferred to the new house he/she plans to purchase. The answer is “no”; liens are not transferable. Liens apply to a particular property and can’t be transferred to another property without the permission of the lender, which you won’t get.

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 hopefully a landlord in the old one. When you have negative equity, you are only one step away from the rental market.

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 — their loan or loans equal 100 percent of the purchase price — have negative equity when they move in. If they had to sell immediately, they could not repay the loans out of the sales proceeds because of the transactions costs. The sales commission alone runs 3 percent-6 percent of the price.

Most home buyers realize this but expect that price appreciation will bail them out. Price appreciation is like a tooth fairy — you needn’t do a thing except put your house with nothing down under the pillow, and come morning (or next year), as if by magic, you have equity. Except that sometimes the fairy doesn’t appear, and this seems to be one of those times. My mailbox is clogged with letters from recent home buyers who are stuck with negative equity because the tooth fairy of appreciation has passed them by.

Lenders are supposed to be more worldly and wiser, but in fact, they are caught up with the tooth fairy of appreciation just as much as borrowers. Nobody forces them to make 100 percent loans.

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 the good fairy of appreciation to reappear. And if she doesn’t? Then you may be forced to build equity the old-fashioned way, by paying down your mortgage.

The writer is professor of finance emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at www.mtgprofessor.com.

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