Equity and Interest
Building equity isn't what it used to be, and at the close of 2010, an estimated 23 percent of homes in the United States lost value [source: Ellis]. Equity is the amount of money you've paid toward the value of a home by lessening the amount owe on a home. For example, if you purchase a $225,000 property and the loan (or principal balance) goes down to $100,000 after 10 years, then your equity is $125,000 -- in a perfectly working system. Unfortunately, with the housing bust of the early 21st century, a home you bought for $225,000 may now only appraise at $150,000 after 10 years and a considerable re-evaluation in the real estate market. Your equity then becomes negative despite all of the money you've paid toward the principal loan. This level of risk is a big factor in buying a new home, even at more affordable selling prices.
Getting a loan at a fixed rate means that no matter the change in market interest rates, your mortgage payment will remain the same month after month and year after year. These fixed rates stay the same, but if a home's value drops significantly, payments are overvalued because the equity gets farther and farther behind as home value declines. An adjustable rate mortgage, or ARM, goes up and down with interest rates and can save home owners in the short term as interest at the start is usually very low, but in the long term interest rates are only partly predictable based on economic factors and trends. Long term payments might increase even as a home's value drops. Refinancing on either type of mortgage is unlikely when the equity is negative, and the mortgage itself is then "upside down" or "underwater" [source: Armour]. Owners are pretty much sunk in with their properties until home values rise again.