Sherrilynn Palladino lives in a modest three-bedroom home with an affordable mortgage about a mile and a half from the ocean in Grover Beach, Calif. She's never missed a mortgage payment during the 10 years she's lived in the neighborhood. In fact, she says, she's never late on any bills. At 60, she'd like to retire, downsize and escape spiraling property taxes in the suburb about half-way between Los Angeles and San Francisco.

But she can't.  The house next door is empty. It's been vacant and in various states of disrepair for three years.

Palladino is a quiet victim of the housing market crash. Call her collateral damage. 

"I'm stuck," she said.  "I can't sell my house for what I paid for it with an empty eyesore next door.  I can't afford upkeep, maintenance, and property taxes.  And I can't retire until I downsize ... I don't know what to do. It's all just a mess and I feel like it's out of my control."

Palladino is one of an estimated 14 million homeowners in America who are now under water -- they owe more on their mortgage than the value of their homes.  She has the misfortune of living in California, where one in three mortgage holders are under water.  Things are even worse in other states: In Florida and Arizona, half of mortgaged homes are under water; In Nevada, the number is 70 percent.

While consumers facing foreclosure and banks facing bankruptcy dominate the economic headlines, millions of other Americans are suffering effects of the housing market collapse that, while subtler, are very real.  Homeowners who are under water often can't move to take advantage of new job opportunities, they can't refinance and take advantage of low mortgage rates, and they generally feel rotten about their prospects. 

Palladino, who is single, would sell her home if she could, move into a cheaper condo and trim her annual property tax bill of $4,700.  But the house next door means that's not in the cards.

"I didn't buy more house than I could afford. I did everything I'm supposed to," she said. "The mortgage is nothing.  But it's the taxes that worry me."

What frustrates Palladino is that as far as she can tell, she's done everything right. Ten years ago, she owned a condo in San Francisco and sensed that the market had become overheated, so she sold and moved to a more modest neighborhood three hours south.

"I had watched the peak and the Internet bubble break and decided to get out of that," she said. "I made a killing selling that condo." 

She wanted to live at the beach, but instead took her hefty down payment and chose a modest single-story home that was a long walk away from the water. 

"I still get the sea air. I can still smell it," she said.

Following traditional financial advice, she bought as much home as she could afford without stretching too far -- a three-bedroom, two-bath home with a fireplace for $419,000. Even with a modest return, she figured she'd be able retire in five to 10 years.

Now, she stares at the overgrown weeds covering the yard of the empty house next door and wonders if she will ever be able to retire -- or if property taxes will slowly drain her life savings while she waits for a housing market rebound that may never come.

Trulia.com

The empty house in better days.

The empty house in better days. (from Trulia.com)

"Every year I wait for a chance to put my house on the market but no luck as that eyesore continues to exist," she said.

Things didn't always look so bleak. At one point, they seemed positively magical.  In April 2005, the house next door was sold to a family for $589,000.  Palladino counted her lucky stars.

"I should have jumped, but I wasn't ready," she said. "I remember thinking, 'Gosh, I can sell for a lot of money and use that for retirement, like you're supposed to.' "

But three years ago, the house next door went back on the market -- the couple that bought it was filing for divorce.  That started the roller coast that Palladino is still on today.  She watched the listing price fall, and fall, and fall, for nearly a year.  At some point, the family moved out, and two years ago, the home was pulled from the market. 

"That's when it went downhill. Then the weeds started to grow," she said. "I knew it was in foreclosure. At one point the weeds were five feet tall. Here I am trying to keep my place up and keep it looking nice, and what's the point?" 

For another year, the house sat vacant. Finally, this summer, a company came and painted the inside of the house. Even with that, the home remained empty through fall.

Then, at the end of September, it was listed for sale at $381,900 -- almost $40,000 less than Palladino paid for her nearly identical home next door in 2002. 

"No one knows they fixed up the inside from the outside," she said. "I watch cars come down the street to take a look. They see the outside and drive right back out."

That wasn't the end of the roller coaster.  The listing was removed in October, according to Zillow.com, suggesting a possible pending sale.  But something went wrong, and the home was relisted for the same price on Oct. 17. 

Why foreclosed homes take so long to sell
Banks aren't in the business of buying and selling homes, yet with an estimated 6 million foreclosures during the last two years, mortgage issuers have turned into giant real estate outlet malls.  All the big banks have real estate Web sites that seem like they belong at Zillow.com or MSN Real Estate.

(For a list, click here)

Because banks, by definition, would rather hold mortgage paper than porches, you'd think they would rush foreclosure sales through the pipeline in an effort to dump properties and turn them into cash.  That's the main defense of the recent robo-signing controversy: Banks have claimed that they need to be as efficient as possible with foreclosures so the market can absorb the bad news and eventually cleanse all the distressed properties. Prolonging the process hurts everyone, they said.

But that's not the whole truth.

Banks must also weigh the potential valuation disaster if they were to release all the foreclosed properties they own (known as REOs, or real estate owned) to the market simultaneously. So many empty homes would drive prices down drastically. That leaves banks in the position of throttling back their sales, trying to strike a balance between liquidating unwanted assets as soon as possible and widespread sales that devalue their own holdings.

That balance point is killing people like Palladino, who simply wants to move on with her life.

"I'm not getting any younger," she said. "I have a number of health issues too, like arthritis.  But for now I've got to keep working."

Rick Koester, the sales agent for the empty house next door, said he now works exclusively on bank-owned home sales. 

"I used to sell high-end homes, but this is all there is right now," he said.

He wouldn't discuss details of the home next door, citing ongoing sales negotiations, but said there are numerous reasons banks might hold onto foreclosed homes for what can seem like an eternity.

"There are a number of reasons banks do what they do.  They don't want to flood the market," he said.  "Iit's usually a nine-month process when they start foreclosure to when the home sells."

Accounting rules offer another possible explanation. In trying to explain why only 30 percent for foreclosed homes have reappeared on the open market in California, Sean O'Toole, CEO of research firm DataQuick, told the San Francisco Chronicle that banks are intentionally holding properties so they can exaggerate the value of those assets. In some cases, lost value doesn't have to be acknowledged until foreclosed sales close in their accounting disclosures.

"With banks in the stress they're in, I don't think they're anxious to show losses in assets on their balance sheets," he told the paper.

Bank owned homes that are in limbo are called "Shadow Inventory" in the real estate industry. It's unclear how many bank-owned homes are sitting empty, but not yet for sale, around the country, because banks don't necessarily have to report them on their balance sheets.  But attempts to quantify this Shadow Inventory have led to alarming conclusions. Earlier this month, Fitch Ratings said there are an estimated 7 million homes in this shadow inventory pipeline – and that it would take more than three years to sell all those bank-owned homes, Fitch said. As these trickle out onto the market, any fledgling recovery in home prices will be threatened, the ratings agency warned.

Palladino said she's read that news, and sees it in real life every day. Empty, bank-owned homes dot her neighborhood, and she worries that even if the house next door sells, her home value will be depressed for years by the others.

"I don't have a chance with all these other houses. I keep reading the recession is over. Oh really?" she said.

Even in the past week, Palladino's sense of being jerked around by the housing market hit both new lows, and new highs.  Koester said on Friday that the home next door has just been pulled from the market because of a pending sale.  It hasn't closed yet, and prior possible sales had fallen apart at the last moment, so he wouldn't talk about it. But the news would provide a ray of hope for Palladino.

But on the other side of the Ledger, on Friday she was laid off from her job as an administrative assistant.  She has savings to ease the blow, so she's hard at work looking for a new job already.

"I cannot believe that people walk away from their responsibilities, like house payments. Never, never would I do such a thing," she said.