Negative equity in real estate

What you’ll learn

• What negative equity looks like - for property investors and owner occupiers
• Why negative equity doesn’t necessarily mean you’re in financial trouble
• What negative equity means for your credit score
• How to reduce the impact of negative equity
• Ways to avoid getting into a negative equity position
   

What negative equity in real estate looks like

Negative equity occurs when a property's value is less than the home loan owing on it.

Here’s an example:
 

Negative equity doesn’t necessarily mean you’re in financial trouble

Time may ‘even out’ negative equity. Provided the market value of your property increases, the equity you have in your home will also increase. So unless you're forced to sell, being in negative equity doesn’t necessarily mean you’re in financial trouble.
 

For investors with several properties, having a property in negative equity might not be bad, provided your overall portfolio is positive.
 

Whether you’re an owner occupier or property investor, try to avoid selling during any market downturn. Because that’s when you’re likely to realise an actual loss.
 

In a hold situation, maintaining cash flow is key. For example, it would be better for a property investor to continue getting rental income in order to cover costs.

Overcapitalisation and negative equity are different

Overcapitalisation means you’ve spent too much money on your home, and you’re unlikely to recoup the money you’ve spent if you sold. It can happen when you use savings or credit cards to finance the work (rather than a home loan).
 

Renovations should increase the value of a home. But there’s a point when upgrades add no further value. In some cases putting more money into your property may not increase its value.

What negative equity means for your credit score

Being in a negative equity situation doesn’t impact your credit history or credit score – these things are affected mainly by the number of applications you make and then your history of repayments.
 

If you’re worried about negative equity and your credit history, the key is to make sure you meet your payment commitments - like mortgage repayments or credit card repayments. If you’re struggling to make your home loan repayments (whether you’re in negative equity or not), you should talk to your bank immediately – most lenders have hardship teams that can work with you to find a way through difficult situations.

How you could reduce the effect of negative equity

If you find you’re in a negative equity position with your current property, what could you do?
 

Whether you’re a home owner or property investor, you may be able to reduce its impact. Simply keep making payments until the property's value increases and your loan balance reduces. Mortgage payments for your home loan don’t change because your property’s value has dropped.
 

Other things you might do include:

1. Improve the property’s value - without increasing debt. For example, if you have savings, you might consider renovating the bathroom or kitchen in an investment to modernise the property and improve its value.
2. Watch the market - as your property’s value increases, your negative equity decreases, so keep an eye out for any trends in the suburb and surrounding area that may play into your favour.
3. Avoid taking risks that could interrupt your immediate cash flow and force you into a sale.
4. Negotiate for a better interest rate with your current provider. Refinancing might be difficult when you’re in negative equity.
    

It may also be wise to reduce risk of negative equity across your property portfolio by diversifying your investments. For example, don’t buy multiple properties in just one suburb. Instead diversify your investment in multiple suburbs, cities or states, so if one property’s value decreases, your other properties are likely to balance out the loss.
 

You might also consider using other assets to build your wealth - like investing in shares, a managed fund, ETFs or alternative currencies. Holding a mixed portfolio can help maximise returns while minimising risk.

How to avoid getting into a negative equity situation

Here are some ways to avoid a negative equity position with your real estate:

• Remember: property is an investment. Ultimately, you’re looking for growth in home value and positive equity. So whether you’re an owner-occupier or an investor, it pays to do your homework before you buy – research many factors relating to the property’s potential to improve in value, even if one aspect is immediately appealing.
• Look for property with opportunities for increased value. For example, a new home that is close to proposed infrastructure upgrades – like a new train station, a new hospital, a new shopping centre, or new schools. This is a particularly good tip for first home buyers.
• Buy in popular or upcoming suburbs. Invest where other people want to live and buy homes.
• Be disciplined. Avoid paying too much for a property (always have a limit before attending an auction).
• Don’t put so much value into your property that it would be hard to get your money back. Think about what would happen if you had to sell quickly. Look for high value, low cost ways to add value.

To sum up

• A negative equity position occurs when the amount owed on a property is greater than the value of that property.
• A good strategy to offset the effects of negative equity is to hold the property if there’s a downturn in the market. Continue your mortgage repayments (use our repayment calculator to see the benefits of extra repayments) and reduce outstanding debt, while waiting for the property's valuation to increase.
• Diversify your investment property portfolio across multiple locations to offset risk.
• Do your research before you become a property owner. Find out what’s happening in the national and local housing market, and don’t pay too much.