Negative equity in the property and home loan sector refers to the market value of the property being less or below what is outstanding on the home loan. The homeowner or investor owes more on their mortgage than the property is currently valued at.
The current situation in the property market has seen this concept of negative equity crop up in media reports. It’s not something that many may have heard of before as ‘positive equity’ and ‘building equity’ are more usually associated with property purchases and investments. Over time, as the loan payments are made, the homeowner builds equity in the property. They owe less than the property is worth and hence own a greater percentage than the lender.
We’re hearing this now as a result of the fall in property values being seen in many areas across the country. This situation can be seen as a positive in many ways but can also have downsides, especially for sellers.
A fall in property prices or values can make it easier for some buyers to get into the market. But for sellers, a fall in the value of their property may be a deterrent to selling at this time. Sellers may be in a negative equity position and selling may be a problem for them. The proceeds of the sale not meeting the amount they need to pay out their loan.
If sellers are in this position, they may not be prepared to put their properties on the market which may cause a fall in supply. Prices may be lower, but if more buyers are vying for the same properties, it may be more difficult to buy. In economics, a low supply and high demand scenario can typically lead to rising prices as buyers bid higher to secure the property they want.
The property market is constantly going through a cycle of fluctuations, caused by various economic conditions. We provide this explainer on negative equity and what it may mean for you.
Negative Equity – Explainer
Equity is essentially ownership. An individual or business owns more than they owe. With an asset such as property, having equity means owing less on the finance than the value of the home, that’s positive equity.
Negative equity is owing more than the value of the asset. The home loan balance is higher than the property is valued at. For example, if a property is worth $1m and the homeowner has a mortgage for $1.1m, they have negative equity of $100,000 in the property.
The situation happens when property prices fluctuate in the market cycle. The property in the example above may have initially been worth or purchased for $1.3m with the $1.1m mortgage, as a result of market forces that value has fallen.
To work out the equity position, deduct the amount that is currently outstanding on a home loan from the value of the property. If the result is a positive figure there is equity in the property if it is a negative, the homeowner has negative equity.
This is not an issue unless you are planning to sell or refinance as lenders and buyers will be looking at the value of the property. Sellers will end up owing extra after finalising their mortgage if they choose to sell in a negative equity situation.
Negative Equity and New Home Loans
Negative equity is more an issue for existing mortgagees looking to sell or refinance rather than buyers taking on new home loans. When the term is associated with lower property prices, it can be positive timing for buyers. Their deposit can go further with lower prices and for some, it may mean avoiding Lenders Mortgage Insurance.
The concept of ‘equity’ does come into play with new home loans with the LVR – loan-to-value ratio. When applying for new home loans, lenders are looking at the LVR – the amount of the loan compared with the value of the property.
Loans for a property which exceeds the value of the property is not usually requested. Additional funding may be required where the purchase includes buying a property and financing for rebuilding or major renovations. These are typically provided with Construction Loans for the building and a home loan for the land or existing property.
Negative Equity and Refinancing
When seeking to refinance a home loan from a position of negative equity, homeowners may face issues. If the value of the property has fallen below the loan required to refinance, they may not be able to source affordable funding or they may be required to pay LMI, even if not required on the initial loan.
If can be advisable to wait out the property price cycle and refinance when prices start to rise again.
What to Do re Negative Equity
Homeowners affected by falling house prices can choose to simply ‘wait it out’ until the next positive property cycle kicks in before selling or refinancing.
If the value of your property has decreased and placed you in a negative equity position, consider making additional mortgage payments to reduce debt. This will increase your equity in the property.
Homeowners may consider increasing the value of the property with home improvements.
Connect with Yes Home Loans brokers on 1800 000 937 for further information if negative equity is an issue for you.
DISCLAIMER: THE INTENTION OF THIS ARTICLE IS TO PROVIDE INFORMATION OF A GENERAL NATURE ONLY. THE ARTICLE IS NOT PROVIDED WITH THE INTENTION OF BEING THE ONLY SOURCE OF INFORMATION ON WHICH PROPERTY BUYERS SHOULD MAKE THEIR DECISIONS. BUYERS WHO NEED GUIDANCE AND ADVICE ON PROPERTY LOANS BASED ON THEIR INDIVIDUAL CIRCUMSTANCES ARE ADVISED TO CONSULT WITH A SPECIALIST MORTGAGE BROKER OR FINANCIAL CONSULTANT. NO LIABILITY IS ACCEPTED FOR MISREPRESENTATION OF FOR ANY ERRORS IN DATA, POLICIES AND SPECIFIC DETAILS THAT HAVE BEEN OBTAINED FROM OTHER SOURCES.