I found a great article on ajc.com titled, Does negative equity cause foreclosures? The article points out that it is zero money down, not subprime loans that led to the mortgage meltdown.

What I liked most about the article was its explanation of negative equity.

A huge percentage of all buyers have negative equity up front and don’t know it because they define “equity” as the market value of a home less its mortgage debt. If a sample home was bought for $500,000 and has a $455,000 mortgage (91 percent) then with such thinking it would appear that the owner has equity worth $45,000.

In theory this sounds about right but in reality it costs money to sell a home, say 8 percent for marketing costs and closing or $40,000 in this case, assuming the property can be re-sold for $500,000.

The mythical equity number shrinks even further when you look at real-life marketplace conditions. NAR says “the national median existing-home price for all housing types was $173,000 in May 2009, down 16.8 percent from a year earlier.”

Let’s try that equity calculation again: $500,000 less 16.8 percent = $416,000. $416,000 minus 8 percent = $382,720.

This is what we are seeing today.  The above is a simple example of how short sales and foreclosures come to be.  Of course, in a market like today when there are more sellers than buyers home values decrease which just makes the equation that much worse.