Table of Contents
- What Is Negative Equity?
- Key Takeaways
- How Negative Equity Works
- How To Increase Home Equity
- How Negative Equity Is Calculated
- Negative Equity's Economic Implications
- Impact on the Borrower
- Impact on the Economy
- Important Note
- Special Considerations
- What Are the Implications of Negative Equity?
- How Can I Tell if I Have Negative Equity?
- The Bottom Line
What Is Negative Equity?
Let me explain negative equity directly: it happens when the value of your real estate property drops below the outstanding balance on the mortgage you used to buy it. You figure this out by subtracting your current mortgage loan balance from the property's market value right now.
Key Takeaways
Negative equity is straightforward—it's when your property's value falls below your mortgage balance. People often call this an underwater mortgage. This situation typically arises from declining real estate values, like during a housing bubble burst, recession, or depression.
How Negative Equity Works
To get negative equity, I need to start with positive equity, which is just home equity. Home equity is your ownership stake in your home—it's the current market value minus any liens or debts on the property. This value changes as you pay down your mortgage, reducing the loan and building your equity. It also shifts with your home's market value fluctuations.
If you bought your home with a mortgage, the lender has a claim until you pay it off. Your home equity is the part of the home's value you own outright.
How To Increase Home Equity
You can build home equity by putting down a bigger payment when you buy the property. As you make mortgage payments, part goes to interest and part to principal, reducing what you owe and increasing your equity over time. If your property value rises, that boosts your equity too. Essentially, any increase in the gap between your mortgage balance and your home's value means more equity for you.
How Negative Equity Is Calculated
When your home's market value drops below what you owe on the mortgage, you're in negative equity. Take Sally, for example: she bought a $400,000 home with a $40,000 down payment and a $360,000 loan. A few years later, she owes $340,000, but the home is now worth $300,000. That gives her -$40,000 in equity, calculated as $300,000 minus $340,000.
Selling a home in this state turns into a debt for you, because you'd owe the lender the difference between the sale proceeds and the mortgage balance. In Sally's case, she'd need to pay the bank $40,000 to sell.
Negative Equity's Economic Implications
Negative equity often hits when you buy with a mortgage and then real estate values crash due to a housing bubble, recession, or depression. For instance, if you financed a $400,000 home with $350,000 and the value drops to $275,000 the next year, you're $75,000 underwater.
Impact on the Borrower
If you're a borrower with negative equity, your options shrink—you might not refinance, and selling means taking a loss equal to the negative amount. It could trap you in your current location, making it hard to move for work. Missing payments damages your credit, and job loss could lead to default or foreclosure, bringing serious stress.
Impact on the Economy
Banks suffer losses from defaults and foreclosures, which cuts their lending and tightens money supply. Consumers with negative equity spend less, slowing growth. A housing price crash can spike foreclosures, unemployment, and recessions. Governments end up spending more on aid, straining budgets.
Important Note
Remember, an underwater mortgage is when your loan balance exceeds your home's value. This was widespread during the 2007-2008 financial crisis with falling housing prices, and as the Great Recession showed, mass negative equity ripples through the entire economy.
Special Considerations
Don't confuse negative equity with mortgage equity withdrawal, where you borrow against your home's value—it reduces equity but isn't negative. To avoid negative equity, buy what you can afford with a large down payment, and for current owners, upgrades can raise your home's value.
What Are the Implications of Negative Equity?
Negative equity brings financial distress, complicating home sales or new financing like home equity loans or lines of credit.
How Can I Tell if I Have Negative Equity?
Get your home's current value via appraisal or online tools, then subtract your outstanding loan balance from your mortgage statement—that's your equity, positive or negative.
The Bottom Line
Being underwater means negative equity—your home's value is less than your mortgage debt, often from market drops like bubbles or recessions. This makes selling tough without losses.
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