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

Man mulling over home loan.

With each repayment you make on your home loan, the equity you hold in your home goes up, until eventually you’ll own your property outright. But your equity can also go negative in some cases. We look at what that means and what you can do about it.

First of all, what is equity?

Put simply, equity is the value of a property minus any outstanding debts attached to it. The amount of equity you have will change over time as the value of your home goes up and the amount you owe to the bank goes down. 

To calculate your equity, use the following formula:

Equity = market value - outstanding debt

Example: Nathan takes out a $450,000 loan to purchase a $500,000 home. Two years into the mortgage, Nathan has made $20,000 in repayments, meaning he still owes $430,000. Assuming property prices have not changed, Nathan will have $70,000 in (positive) equity.

Negative equity explained

If you owe your bank more than your home is currently worth, this is known as having negative equity. Selling your home would yield less than you originally paid for it, and you would have to pay out of pocket to close the mortgage.

Example: Mary owes $360,000 on a property she had bought for $400,000. But the market nosedives, leaving her home worth just $340,000. In this scenario, Mary’s equity would be negative $20,000. 

Assuming the value of Mary’s other assets (for example, her car and savings) are less than $20,000, then her net worth will be negative too. That is, she will owe more than the total value of her assets.

What can lead to negative equity?

Since property prices tend to rise over time, most people won’t have to worry about negative equity. But there are a handful of occasions where the amount you owe to the bank can wind up eclipsing the current value of your home. For example:

  • You bought at the top of the property cycle and prices have subsequently fallen
  • You overpaid for a property and not enough time has passed for equity to build up
  • You bought with a low deposit and the market has dipped slightly

When is it a problem?

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 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, your bank might be forced to get their mortgage insurer involved. The insurer will pay out the shortfall to your bank before setting out to retrieve the amount you owe, which can be quite a messy process.

Having negative equity can also make it difficult to refinance, which can be particularly frustrating if the rate you’re currently paying isn’t all that competitive.

How to prevent negative equity

Purchasing a home with a larger deposit is a good way to keep your home equity from dipping into negative territory. 

Banks recommend having a deposit of at least 20% anyway, as it shows you’re capable of setting aside money regularly and reduces your risk profile in their eyes. If you can come up with a deposit of that size or larger, it can also act as a buffer in case of any price falls.

You should also make sure you don’t fall behind on your loan 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.

What to do if you find yourself with negative equity

Having negative equity can take a lot of the wind out of your sails, but the problem will usually resolve itself as the market improves and you continue to make repayments on your home loan. If you want to speed things up, here are a few things you can do:

  • Get ahead on your mortgage by making extra repayments 
  • Renovate to increase your home’s value 
  • Avoid redrawing from your mortgage
  • Arrange for an independent valuation to get a clearer idea of what your home is worth

For more information on home loan features, visit Mozo’s home loan guide hub. And if you’re looking to compare mortgage options, browse our home loan comparison page, where you’ll be able to filter your search by rate and type.

Home loan comparisons on Mozo - last updated 11 August 2022

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