What Is Negative Equity On Your Mortgage?
May 28, 2024
5-MINUTE READ
AUTHOR:
VICTORIA ARAJEquity refers to the amount of your home that you own. In most cases, your home equity increases over time as you make your mortgage payments.
Negative equity means you owe more on your mortgage loan than the current value of your home.
When property values fall, you may be left with no equity or negative equity in your home because it’s worth less than you owe your lender. To calculate how deeply “underwater” your mortgage is, subtract your home’s current market value from your outstanding mortgage loan balance. To understand when negative equity can happen – and, most importantly – how to avoid it, keep reading.
How Does Negative Equity Work?
Negative equity occurs when the value of an asset you own is less than the outstanding balance on the loan. A lender may refer to a loan with negative equity as “underwater” or “upside-down.”One commonplace scenario that typically results in negative equity is when housing prices plummet.
Let’s say you bought a home worth $150,000 and took out a $135,000 loan. Fast forward 1 year later, and your local housing market has experienced a downturn. Homes are selling for less than the previous year – and it’s dropping your home’s value.
Your home is now worth $120,000 instead of the $150,000 you originally paid for it, and you owe your lender around $134,000 after making a year’s worth of payments. In this scenario, you would have $14,000 in negative equity because you owe your lender $14,000 more than your home is worth.
What Can Cause Negative Equity?
Negative equity can occur in several ways. Here are a few examples of how it can happen:
- Buying a home when market prices are high, then local home prices fall
- Missing payments early in your loan term and interest begins to balloon
Negative equity can cause several problems for homeowners. You may struggle to refinance your mortgage loan because lenders can’t lend more money than a property is worth.
In our earlier example, you could only refinance up to $120,000 of your home loan because that’s what your home is worth. You’d need to pay off your negative equity before you qualify for a refinance loan.
You may also find it challenging to sell your home. When you sell your home, you typically use the sale proceeds to pay off your existing mortgage. If there’s still an outstanding balance after the sale, you’ll need to cover the difference between the sale price and what you owe on the mortgage before your lender can declare your loan paid off.
What Can You Do To Reverse Negative Equity?
While there’s no guaranteed way to reverse negative equity, there are strategies you can apply for some financial relief. Let’s take a look at a few.Continue Making Payments
Every time you make a mortgage payment, you gain a small amount of equity in your property. If you can afford it, consider making extra payments on the loan to bring your total loan balance down faster. When home values rise again, you can eventually sell or refinance your home.Make Home Improvements
Consider making permanent home improvements. These improvements can increase the value of your property and help shield it from negative equity. Some examples of improvements that can increase a home’s value include:
- Replacing large appliances with newer models
- Adding a home security system
- Replacing old, worn-out cabinets in the kitchen
- Installing a patio in your backyard
Only permanent improvements count toward your home’s value. Purely aesthetic changes, like painting, and temporary improvements won’t build equity.
Sell Your Home
Negative equity won’t technically stop you from selling your home, but a mortgage lender won’t settle your loan until you’ve paid your entire outstanding loan balance. If you sell your home for less than your current mortgage, you must pay your lender the difference in cash.
Refinance Your Loan
When you refinance, you replace your original mortgage loan with a new one. With a refinance, you can lower your monthly payment by getting a lower interest rate or lengthening your loan term. A refinance won’t increase your home’s value, but it may help you avoid foreclosure while you wait for local home values to rise.
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