We hear a lot about home equity, but what is it really? Your equity is the portion of your home that you own, and it increases over time as you pay down your mortgage. Conversely, negative equity occurs when your mortgage balance is higher than your home’s market value. Some people refer to it as being “underwater” or “upside down” on a property. 

Negative equity is not common, but it is important to understand how it works, what may cause it, and strategies for preventing or mitigating it.

How Negative Equity Works

Negative equity occurs when the value of an asset is less than the outstanding balance on its loan. For instance, if you purchase a home for $200,000 with a $180,000 mortgage and a year later your home’s value is reduced to $160,000, your mortgage loan debt might exceed the actual value of the home. We see this more commonly with car loans, but it can occur with mortgage loans as well.

Causes of Negative Equity

Negative equity can occur for several reasons, such as buying a home at high prices followed by a market decline, or missing payments early in the loan term and experiencing increased interest. These issues can make it hard for homeowners to refinance the property as lenders usually won’t lend more than the home’s current value. For example, if your home is now worth $180,000, that’s the most you could refinance; you’d need to resolve any negative equity first. Likewise selling a home can be more challenging. If the sale price doesn’t cover the remaining mortgage balance, you'll have to pay the difference to close the loan and may have difficulty getting a mortgage to help finance your next home.

Strategies to Address Negative Equity

While there’s no guaranteed way to eliminate negative equity, here are two strategies that might help.

1. Continue Making Payments and Wait for the Market to Improve: Each mortgage payment increases your equity. Continue making payments on time and in full, and wait for market conditions to improve and property values to rise again. Making extra payments to reduce the loan balance faster can help.

2. Make Home Improvements: Invest in permanent upgrades that can boost your home’s value, such as:

1. Upgrading major appliances
2. Installing a security system
3. Replacing old kitchen cabinets
4. Adding a patio

Keep in mind that only lasting improvements count toward your home’s value.

3. Refinance Your Mortgage: Refinancing means taking out a new loan to replace your current one. This can lower your monthly payments and help you manage your finances until the market improves, even though it won’t increase your home’s value. Remember, you might need to find a way to cover the difference, but your lender will help you walk possible solutions.

4. Work With a Certified Mortgage Planning Specialist: Choose a CMPS^® from the get-go who advises you over the life of your loan, not just until your closing. Already in the home? Find a CMPS^® in your area who can help you work through various scenarios and craft a personalized plan forward.

There are thousands of mortgage originators who can push a loan through, but there aren’t many who promise an excellent mortgage experience that help you edge out the competition. Learn more in a free initial consultation with the Leo Anzoleaga Group — schedule yours here!