What Does it Mean to Have a Negative Equity?


One of the most common real estate term you hear when you purchase or refinance a home is equity.

At its core, a home equity simply means ownership. The amount of equity you have on your home therefore is the extent of ownership you possess in your property.

Take for example, you have a mortgage for a home that is worth $350,000 in the market. If you were able to pay the traditional 20 percent down payment which is $70,000 and used financing to pay the rest, that means you own 20 percent of the home. That 20 percent is your home equity.

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What is a negative equity?

A negative equity indicates that you owe more on the home than it is worth in the market. This commonly occurs when the market slowed down or home prices plunged after you made your purchase or refinance.

For instance, you took out a mortgage for a $250,000 home. You were able to pay $12,500 as down payment, which is 5 percent of the home price. You now then owe $237,500 to the lender, plus interest and mortgage insurance charges. Your home equity is 5 percent, plus the accumulating payments you make from the start of your mortgage clock.

However, three years after you took out the loan, demand for housing in your region slowed down, causing home prices to decrease, including yours. While it was worth $250,000 when you got your mortgage, the market now values your home at $200,000.

Therefore, instead of the original 5 percent plus three years of accumulated equity, you are now at risk of being underwater, another term for having negative equity.

While this does not essentially affect your mortgage payment, it could be a big deal when it comes to refinancing or selling.

Aside from decelerating home prices, there are other factors or events that may cause you to have a negative home equity.

Why am I upside down?

a.) Market volatility. Home prices are anything but stable. It is widely affected by equally volatile market factors and can change as fast as any other market measures (e.g. interest rates). If you were able to buy your home when the prices were at their lowest, you have a huge potential of selling it at a higher price even at the slightest event of appreciation. Conversely, if you bought the home at its peak price and decide to sell later, you can never expect to sell at the same high.

b.) Interest-only mortgages. These mortgages are usually structured so that at a predetermined initial period, you are only making payments on your mortgage’s interest. This makes initial payments very low and therefore, attractive to many borrowers. After this period expires, however, the borrower must make a lump sum and begin paying off the principal part of their mortgage, causing their mortgage payments to soar.

By making little to no payment during the initial payment period, the borrower is also gaining little to no equity, making him or her very vulnerable to home price volatility.

c.) Less down payment. When you’re taking out a loan to fund your home purchase, the down payment automatically becomes your equity. If you pay only a small amount, you are also venturing out with little equity, which means more time needed to earn it and pay off your loan.

d.) Housing crisis. A housing crisis such as what happened back in 2008, pushes home prices down, easily destroying homeowner equity on their properties.

A negative equity, if you don’t have any plans of refinancing or selling in the near future, isn’t much of a problem. If you are current on your payments and have no financial issues in continuing it, then you shouldn’t have to worry.

Keep up to date with trends in home prices or consult a real estate agent about your future mortgage plans.

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