What is negative equity and what can you do about it?

Negative equity is when the amount you owe on your home loan is greater than what the property is worth in the current market. In other words, the debt you owe is more than the total value of the asset.

If you fall into negative equity, it can be improved over time as you pay off your mortgage. However, negative equity can become a problem if you need to sell your home or you want to refinance your mortgage – which is when you switch from one home loan to another.

Negative equity can occur when your home declines in value, but because property prices have historically risen in Australia, it’s fairly unlikely to happen. You may also fall into negative if you pay too much for your home at the outset, and property prices slump.

In this guide, we’ll look at what is negative equity, what causes it and what you can do about it.

Negative equity is when the amount you owe your home loan lender is higher than what your home is currently worth in the property market.

If you were to sell your home while in negative equity, you would get less than what you originally paid for it, meaning you would owe money to the bank and would need to pay out of pocket to discharge your mortgage.

You can calculate your home equity using the following formula:

Market value - outstanding debt = home equity ($)

Negative equity can become a real problem when a homeowner has to sell because they can no longer afford their mortgage.

It means selling their home won’t cover the cost of the home loan they’re trying to get rid of, so they will owe their lender an outstanding debt and be on the hook for more money they simply don’t have.

Example of negative equity

Mary owes $800,000 on a property she had bought for $900,000. But the market nosedives, leaving her home worth just $750,000. In this scenario, Mary’s equity would be negative $50,000.

Assuming the value of Mary’s other assets (such as her car and savings) are less than $50,000, then her net worth will be negative too. That is, she will owe her lender more than the total value of her assets.

At a national level, property prices have historically risen over time in Australia, so most people won’t have to worry about negative equity.

This has been suggested by the Reserve Bank of Australia (RBA), which estimated in October 2023 that only around 0.1% of home loans in the country are in negative equity.

Still, there are a handful of circumstances where the amount you owe your lender can become greater than the current value of your home.

Declining market value and economic downturns

If you buy at the top of the property cycle and house prices subsequently fall, you are at risk of negative equity, especially if you bought with a low deposit.

This can happen on a small scale, when property values fall in a certain area of the market – we’ve seen this in some mining towns where house value has decreased as the demand for workers has also fallen.

It can also occur on a larger scale, when there is a recession and house prices fall across a wider section of the market.

Overpaying for a property

Paying more than what a property is worth at the outset is another way to fall into negative equity.

You might overpay for a home if you feel emotionally invested in it, and if you overpay and not enough time has passed for home equity to build up, you may be in the negative.

Buying with a low deposit

If your first home loan deposit is less than 20% of the home’s value, then one of your options for buying is a low deposit home loan.

While these home loans get Australians into the property market sooner, it means the borrower has a high loan-to-value ratio (LVR) – and the higher your LVR, the smaller percentage of the property you own.

If you buy with a low deposit home loan and the market dips slightly, trouble can arise as you could be in debt for more than the house is worth.

Overcapitalising on the property

You can overcapitalise on your property by spending more on home renovations than the value it creates.

In other words, you have invested more capital than what you can reasonably expect to get back from the investment.

By doing this, the borrower has added more to their home loan than what the property is actually worth in the housing market.

Negative equity is mainly a problem if you plan to put your property on the market. That’s because when you sell a home with a mortgage, the proceeds of the sale are used to pay off your remaining debt.

If the amount you receive from the sale isn’t enough to cover the debt, you’ll have to make up the difference some other way, such as by dipping into your savings or selling other assets.

If you can’t come up with the necessary funds to discharge your mortgage, your lender might be forced to get its mortgage insurer involved. The insurer will pay out the shortfall to your lender before setting out to retrieve the amount you owe, which can be a stressful process.

Negative equity can also prevent you from refinancing your mortgage.

This is because when you apply for a home loan, your lender needs to ensure you’re not borrowing more than what the property is actually worth, as the property acts as the lender’s security if you can no longer pay for your mortgage.

Being unable to refinance their home loan can put serious financial strain on borrowers who are struggling to make repayments and would benefit from a lower home loan interest rate.

If you are experiencing financial difficulty, contact your lender immediately and speak with the financial hardship team. You can also access free financial counselling and mental health support from the following services:

Free financial counselling

• National Debt Helpline – 1800 007 007
• Mob Strong Debt Help – 1800 808 488
• Small Business Debt Helpline – 1800 413 828

Mental health support

• Lifeline – 13 11 14
• Beyond Blue – 1300 22 4636

You can work out if your property is in negative equity by calculating your property’s value against your current mortgage balance. If you find that your property is valued at less than your home loan balance, you are in negative equity.

There are a few ways you can determine your home’s current market value:

Use a property estimate tool

Free property estimate tools are available on Domain and realestate.com.au. These tools can also give you an idea of the current market by allowing you to see other properties that have recently sold in your area.

Property appraisal

A property appraisal is typically carried out by a local real estate agent and is usually done for free. An appraisal is purely an estimate of how much your home might sell for in current market conditions, and it isn’t legally binding.

Instead, a property appraisal relies on the real estate agent’s knowledge of the local area and takes into account various factors including the location of your home, the number of bedrooms and bathrooms it has and the size of the land.

Property valuation

A property valuation is an independent report completed by a licensed valuer, and unlike property appraisals, it is recognised in court. You’ll also need to pay for the service.

As they can be legally binding, a property valuation report is comprehensive and based on facts, so it doesn’t take into account market sentiment.

Bank valuation

Bank valuations are often required by lenders to establish your loan-to-value ratio, and are purely intended for home loan applications.

Negative equity doesn’t do you any serious harm unless you need to sell your property or you want to refinance. If you’re able to stick it out, negative equity will usually resolve itself as the market improves and you continue to make repayments on your home loan.

Here are a few things you can do to increase your home equity:

Make extra repayments on your home loan

Making voluntary extra repayments on your home loan can help you pay off your debt faster, and while you’ll be spending more on mortgage repayments in a shorter time frame, you’ll benefit in the longer term by spending less on interest.

Mozo research has found that you can save up to $100,000 in interest by making extra repayments on your mortgage, so it’s absolutely worth considering – whether you’re in negative equity or not.

Before making any extra repayments, check with your lender if there are any fees or constraints on the amount of extra repayments you can make each year.

Don’t redraw from your mortgage

If you’ve made extra repayments on your mortgage, a home loan redraw allows you to dip back in and redraw those payments to use for another purpose.

As mentioned, extra repayments can help you pay off your mortgage faster, so you should avoid redrawing if you can to stay on top of your debt.

Organise a property valuation

Arranging for an independent property valuation will help you get a clear idea of what your home is worth in today’s market, and how it might have changed over time.

Consider renovating

Consider renovating to increase your home’s value – though you’ll want to add new features or improvements that are sought after by potential homebuyers.

The goal with any renovations is ultimately to attract a return on investment, so you’ll want to ensure they are carefully budgeted – beware of overcapitalising on the property when going this route.

Getting a property valuation may also help you decide what type of renovations are likely to attract the largest return on investment.

Contact your lender

Whether you’re experiencing negative equity or not, you should contact your lender as soon as you can if you’re struggling to meet your home loan repayments.

You’ll be put in contact with your lender’s financial hardship team, which will help set up a payment plan or modify your home loan for you – either temporarily or long term.

There are a few steps you can take to help prevent negative equity, including:

Buy with a deposit of at least 20%

Purchasing a home with a home loan deposit of at least 20% is a good way to keep your home equity from dipping into negative territory.

Lenders generally recommend a deposit of at least 20% of the property’s price because it shows you’re capable of setting aside money regularly and reduces your risk profile in their eyes.

Having a larger initial deposit means you are able to take out a smaller home loan, and this borrowed portion of the property’s value is known as a loan-to-value ratio.

If you can come up with a deposit of 20% or more (some home loans even require 40% deposits), it acts as a buffer in case of any market price falls, because it gives you higher home equity from the very start.

You can also help prevent negative equity by making sure you don’t fall behind on your mortgage repayments.

Home equity increases as you pay down your loan, so it’s important to pay both the principal and the interest and only take a repayment holiday if you absolutely need to.

Research where you want to buy

Negative equity can occur when the amount you owe your home loan lender is higher than what your home is currently worth in the property market, so it’s important you do your research from the start.

You’ll want to ensure the property is likely to experience growth in value over time, so consider the property itself, the area where it’s located and its proximity to current and planned infrastructure.

Don’t overpay or overcapitalise

Part of doing your research involves making sure you don’t overpay for your home from the very beginning. To do this, you may want to organise an independent property valuation or look into recent sales in the area of similar-sized properties.

Negative equity is when the amount you owe on your mortgage is higher than what your home is worth in the current property market.

However, having negative equity isn’t inherently bad – it only becomes a problem if you need to sell your home or you want to refinance. If you sold your property while in negative equity, you would owe the bank the shortfall.

Negative equity typically occurs when your home declines in market value or there is a wider economic downturn which affects property prices.

Thankfully there are ways to handle negative equity, including making extra repayments on your mortgage, renovating or getting in touch with your lender.

Want to get proactive about your home equity? You can speak to your lender or mortgage broker and compare home loans to see if you can get a better interest rate.