What is negative equity?
Updated October 20, 2022
In order to understand what negative equity is, it’s helpful to know what home equity is. Home equity is the difference between your home’s market value versus the outstanding balance you have left to pay off your property. To calculate your home equity, subtract the amount you still owe on your home from its current appraised value. If that calculated amount comes out as a negative number, and you owe more than your home is worth, then you have negative equity. This can also be known as being upside down on your mortgage. Your home equity fluctuates as the housing market changes and when you pay off any loan amount.
What causes negative home equity?
There are many factors that contribute to negative equity, some of which are out of your control. When the overall housing market is sluggish or declining, it could cause home values to plummet. You might have purchased a home at peak market value, but if the housing market drops, it could certainly lead you to negative equity. But despite circumstances outside your control, maintaining your home and making sure it’s in good condition contributes to its value and helps you avoid negative equity. If you let your home deteriorate, the value of your home will decline. Making a small down payment when you first buy your home also makes it more likely to have negative equity later on.
How do you avoid negative equity?
Putting a larger down payment on your home can significantly help you avoid negative equity because it means you’ll owe less to the bank from the very beginning. Plus, purchasing a home you can actually afford helps you dodge negative home equity because you’re less likely to fall behind on monthly payments—another reason many fall into issues of negative equity on their homes.
Researching market trends and predictions is a smart way to stay on top of the real estate market and avoid overpaying at the top of the market.
What are some of the risks of negative equity?
It might be difficult to refinance if you have negative equity, though it can help with some of your high costs. Lenders do not give out money for more than your property’s value. Typically, you use the money you make from your home’s sale to pay off your outstanding mortgage. If there are still balances that need to be paid after your home’s sale, you have to pay them off before the lender can close your loan. Negative equity can also make your home difficult to sell since it has depreciated in value. In many cases, it might be better to wait to sell your home so you can build up equity.
Is it possible to sell a home with negative equity?
It is possible to sell your home if you have negative equity, but you must repay the difference between the sale price of your home and the balance left. If you don’t have enough money to do this, you can let the bank foreclose on your home.
Another option is to do a short sale, which means selling your home for less than it’s worth. To pull off a short sale, you’ll need to find a buyer and then approach your lender. The lender isn’t obligated to agree to a short sale, though, and beware that it can hurt your credit—just not as significantly as a foreclosure, which makes it a decent option if you find yourself in a difficult situation.