All About Negative Home Equity

When purchasing a home, its value typically increases over time. That being said, there are scenarios where a home’s value can depreciate, leading to a state of negative equity. While this can be alarming, not everyone experiencing negative equity will be financially impacted. Below is a resource guide to help you better understand negative equity and its impacts on your home.

Definition

Home equity can be defined as the difference between how much someone owes on their mortgage and how much their home is worth. That said, negative equity is when a home’s value falls below the amount someone owes on it. Negative equity can make it hard to refinance or sell a home, as it cannot be immediately reversed.

Causes

In many cases, negative home equity is caused by economic downturns, such as depressions or recessions. The Great Recession, which occurred from 2007 to 2009, is a prime example of when homeowners saw an increase in negative equity. But, economic downturns are not the only cause of negative equity. Falling behind on mortgage payments is one of the easiest ways to incur negative equity in your home. Borrowing against a home’s equity is another way a homeowner can become “upside down” on their mortgage. Negative equity can also occur if a homeowner makes little or no down payment on their home, and housing prices begin to fall. 

Prevention

While falling into negative equity is not always within someone’s control, there are ways you can actively prevent it from happening. The easiest way to do so is by shopping for a home within your budget. It’s also wise to not take on a larger mortgage than you can afford. Additionally, making a larger down payment can increase your home’s equity more quickly. Financing home renovation projects can also increase your home’s resale value, which can lower the odds of experiencing negative home equity in the long run. 

Significance

Even though negative home equities may sound alarming, they should only concern homeowners who plan to refinance or sell their homes soon. If you intend on staying in your home long-term while making on-time mortgage payments, negative equity won’t affect you. That being said, if you plan to sell your home while experiencing negative equity, you’ll likely fall short of paying off your home’s mortgage. When selling a home, the remaining balance of your mortgage is typically paid for by the money made from the sale. If the amount you sell for isn’t enough to pay off the remaining balance, you may have to dip into your savings or pay off the balance in another way. One option to consider is asking your lender for a short sale. Essentially, this means that you’ll sell your home for whatever offer you can get, even though it will not cover the entirety of your mortgage. The lender would then forgive the remaining balance. Even so, homeowners should avoid short sales if at all possible, as they can lower your credit score and prevent you from earning a profit when selling your home. 

Courses of action

Although there is no way to quickly reverse negative home equity, there are ways you can gradually get yourself out of this ordeal. The most common way of doing so is by riding out market downturns, as real estate normally increases in value over time. While waiting for the market to strengthen, it’s important to continue making regular mortgage payments to build your home’s equity. As mentioned, another way to pull yourself out of negative home equity is by financing home renovation projects. When doing so, aim for projects that are low-cost but have high returns on investment, such as installing new bathroom hardware or repainting kitchen cabinets. 

While negative home equity isn’t that common, it’s crucial to look out for if you plan on selling your home. It’s also wise to keep a close eye on the home buyer's market, as it’ll help you sell at a more desirable rate. Even if you experience negative home equity because of a downturn in the market, keep in mind that your home’s value will likely increase over time. 

 

Hunter Morrison

About Hunter Morrison

Hunter has freelanced for various print and radio publications across Northwest Florida, including The Bay Beacon, Navarre Press, Inweekly, Crestview News Bulletin, and WUWF. He was also the Editor in Chief of the University of West Florida’s student newspaper, The Voyager. In 2023, Hunter moved to Kenai, Alaska to take up a news reporting position with KDLL Public Radio. For fun, Hunter enjoys cross-country skiing, hiking, photography, thrifting, traveling, and looking for the best Thai food around.