Negative Equity: What It Is, How It Works And How To Save Your Mortgage

Building home equity is an essential part of being a homeowner. It helps your property grow in value that you could borrow from now or profit from in the future.

In some circumstances, like an economic recession, a real estate property value can fall below a homeowner's mortgage balance, causing negative equity. This means the homeowner is instead paying more than the home is worth and ultimately losing profit.

Negative equity is possible for any homeowner to experience. However, there are ways to prevent it and even reverse it to ensure you don’t undergo a financial loss. Find out how negative equity works and what you can do to save your mortgage.

What Is Negative Equity?

Negative equity in your home means you owe more on your mortgage than the current value of the property. This is often referred to as being “underwater” or having an “upside-down mortgage.”

Having negative equity won’t cause a problem if you can continue to make monthly payments. However, having negative equity can complicate finances if you want to refinance or sell your home.

What Is Positive Equity?

If the opposite happens and your house is worth more than the balance on your mortgage, then you have positive equity. In that case, the amount of your down payment is immediate positive equity in the home.

With positive equity, homeowners or borrowers may have the opportunity to take out a home equity loan or home equity line of credit (HELOC), or benefit by making a profit from home sale proceeds. Ideally, when you own a property, you sell it once it’s gone up in value rather than down.

For example, let’s say you bought a home valued at $150,000, and that’s the purchase price. You decide to put a 10% deposit down of $15,000. The mortgage makes up the remaining 90% of the loan to value (LTV) at $135,000.

The property then increases in value to $160,000. Your equity in the home is your original $15,000 deposit plus the $10,000 additional value that the property has accumulated. This means if you sold the house today and paid off the $135,000 mortgage, you’d be left with $25,000 in profit. 

How Does Negative Equity Work?

Simply put, negative equity is calculated by taking the current appraised value of a property and subtracting the amount remaining on the mortgage. If you’re left now owing more, this means you’ll take a financial hit if you decide to refinance or sell the property.

Let’s say you have $135,000 total in mortgage on a property worth $150,000. The real estate market shifts, causing the home to be worth only $130,000. This means you’ll have negative equity of $5,000. If you were to sell the property today, you’d have to pay the remaining $135,000 mortgage balance, plus the additional $5,000.

What Causes Negative Equity?

Negative equity often happens during an economic downturn as housing bubbles burst and property values plummet. But negative equity could also be an outcome of specific lending circumstances or simply unfortunate events.

Some causes of negative equity:

• After you bought your home, the values of homes in your area drop
• You secured a loan with high-interest rates and only apply minimal payments toward the loan principal
• You put a minimum down payment toward the home purchase price and home values on the market drop
• You miss monthly payments early in your repayment term causing interest to accumulate faster
• You allow the condition of your home to deteriorate and fail to make necessary repairs
• You borrowed against the home with a home equity loan before the housing market declined
• The house you wanted to buy receives a low appraisal

You might not even be aware when you’re in negative equity, so review your mortgage statement or call your lender to find out how much you currently owe. Then contact a local real estate agent or hire a surveyor to do a valuation of your property to find out if that number is below your balance.

What Happens When You’re In Negative Equity?

It’s important to know that if you’re in negative equity on your mortgage, you won’t lose your home. However, you’ll want to ensure you get on the right track to building equity so that if you decide to refinance or sell your home you don’t experience financial hardship.

If you find your mortgage underwater in negative equity, you could experience the following problems.

• Struggling to remortgage: To qualify for a home refinance, you would need to pay off your negative equity, wait until your property value increases or make enough payments on your loan to have positive equity. Otherwise, a lender can’t loan out more money than your property’s worth.
• Difficulty selling: Typically, the money from a home sale is used to pay off your existing mortgage. If there’s an outstanding balance due to negative equity, you’d need to cover it out of pocket before your lender is able to close on your loan.

How To Avoid Negative Equity

Being underwater in a mortgage isn’t good for any homeowner or borrower and could halt long-term financial growth. To ensure you retain positive equity, here are a few strategic steps you can follow:

Research Current Local Market Conditions

Before deciding to submit an offer on a home, it’s crucial to understand the intricacies of the property value. If there’s an upward trend of increasing market value in the neighborhood of your choice, you can expect to gain equity without having to make updates or additional payments. A professional real estate agent can help you determine whether it’s a good deal or not.

Stay Within Your Budget

Knowing how much mortgage you can afford before closing on a property could save you from experiencing negative equity. Ensuring you can make your monthly payments and have enough in your budget to make additional payments can help you build positive equity from the start of owning your home.

Increase Your Down Payment

Saving up a larger down payment can act as a cushion for equity, especially if you fall behind on your monthly payments. Without a big enough down payment, a negative turn in the market could put you into sudden negative equity.

Don’t Defer Maintenance

Making sure your home is well maintained with the proper materials and attending to any necessary repairs can help your property retain value in case you need to sell.

Selling A House In Negative Equity

If you need to sell your house with a mortgage underwater, you could be at a significant economic disadvantage. Selling your home at a loss is not something you should choose to do. But it might be necessary in some instances, such as selling to avoid foreclosure. Your least consequential option would be to pay off the remaining negative equity at the sale if you can afford it.

If it comes down to it, you might only be in a position where you must go through with a voluntary foreclosure or arrange a short sale with your lender if they will agree to forgive the remaining balance after your home sells. However, either route can negatively impact your creditworthiness or ability to buy a home again in the future.

Whichever option you take to get out of the financial burden, make sure you have a plan to get back on your feet.

Can You Reverse Negative Equity?

Most of the time, negative equity is only temporary and homes tend to appreciate. As real estate prices rise and you continue to make mortgage payments, over time your negative equity will likely reverse.

Borrowers with an upside-down mortgage have a few different options to help get out of negative equity.

Make Additional Payments

Depending on what your lender allows and your loan terms, it may be in your best financial interest to make an additional lump sum payment toward your mortgage balance or increase your monthly payment.

Refinance Your Mortgage

Modifying your loan with a refinance could give you the opportunity to reduce your monthly payments, lower your interest rate, extend your loan term or remove your private mortgage insurance (PMI).

However, refinancing a home loan with negative equity is more complicated than a standard refinance and is often difficult to secure. Your lender might require you to pay the difference of the negative equity compared to your home’s value in cash since they cannot loan you more money than the property’s worth.

If you’re unable to come up with a lump sum payment worth thousands of dollars, there are a few special programs you may be able to use to still move forward with a refinance.

Improve Your Home

If you have room in your budget or money in a savings account, you could invest it into upgrading your home to add monetary value. Doing so could help your home stand out, even during a buyer's market.

Some home renovations that offer a high return on investment include:

• Swapping out old appliances
• Installing new flooring
• Remodeling a bathroom or kitchen
• Building a patio or deck and refreshing your backyard
• Finishing your basement
• Upgrading to smart home technology

Rent Out The Home

Whether you rent out the entire home or a room, you can keep the existing loan and regularly use these funds toward the balance on your mortgage. If you decide to rent out your home, you’ll need to confirm with your lender and insurer beforehand.

Wait On The Real Estate Market

If you’re in a position where you can wait it out, the best thing you can do is rely on the changes in local housing values and continue making monthly payments toward your mortgage. It may take some time, but market value usually goes back up eventually.

The Bottom Line: You Can Positively Impact Your Mortgage During Negative Equity

If you find yourself with negative equity in your home, remember that there are plenty of options available to save your mortgage and financial status down the road. As the market continuously fluctuates, always make monthly payments toward your balance, and if possible, keep your home until the market value improves. That way, if and when you decide to sell or refinance, you won’t be in a tough spot.

If you’re considering refinancing your mortgage or want to learn more about paying off your home mortgage and building equity, connect with a local expert who can help today.