What is negative equity?

If you’ve bought a home, you’re likely building equity. Home equity is the difference between what your home is worth and how much you owe on your mortgage. However, there are some situations or conditions where you find yourself with negative equity, which is when the value of a home is less than the debt owed on the property.

If you find yourself with negative equity in your home, understanding the causes and options you have can help you address it.

Key insights

• Negative equity can happen for a variety of reasons, including a rapid decline in home prices.
• The most common way to avoid negative equity is to make a large down payment when buying a property.
• It is possible to take steps to fix a negative equity situation, but you will not get help from your mortgage lender.

What does negative equity mean?

Home equity is the value of a property minus how much is owed on it. Home equity is created when you make payments on your mortgage or when home values increase. For example, if you own a home worth $300,000 and owe $200,000 on it, you have approximately $100,000 in home equity.

Negative equity is what happens when you owe more on your house than it’s worth. Using the example above, if you owe $200,000 on a home that’s now valued at only $100,000, you have $100,000 in negative equity.

A property dropping in value a few years after purchase is the most common reason why a homeowner may find themself with negative equity. In this case, homeowners can choose to wait out the negative equity until they’ve made enough payments on the home or their property value increases.

» MORE: How soon can you refinance a mortgage?

How does negative equity happen?

Vikram Gupta, PNC’s head of home equity, said negative equity most commonly occurs during a fast decline in home prices. For example, negative equity plagued homeowners during the 2008 housing market crisis when home values dropped by $2 trillion in that year alone, according to Zillow.

Negative home equity most commonly occurs when housing prices decline quickly.

Housing markets tend to boom and bust over time, creating periods where negative equity can rear its ugly head when homeowners least expect it.

Chicago real estate investor Tomas Satas of Windy City Homebuyer said the fact that we’ve had several years of housing growth through 2022 means a correction could be on its way. "There will be many people that find themselves upside down in their mortgage who have bought the past couple years," Satas said.

Other reasons your property can decline in value include foreclosures in the surrounding area, natural disasters, conditions of your existing neighborhood (e.g., unkempt nearby properties, proximity to high-crime areas) and additional factors that are outside of your control.

Missed mortgage payments may also contribute to negative equity, so make sure you’re making your payments on time.

How can I avoid negative equity?

There may be scenarios where it's impossible to avoid having negative equity. After all, it’s hard to predict the future, and you may not know your area is heading toward declining property values until it has already happened.

However, there are some steps potential and current homeowners can take to minimize their chances of owing more than their home is worth.

• Be wary of buying in a seller's market. Satas of Windy City Homebuyer says that if the value of a home you want to purchase has shot up in the past year or two, you may want to wait it out. "These markets come and go, and you will save thousands by waiting for a buyer’s market," he said.
• Make payments on the home. Homeowners can also avoid negative equity by continuing to make payments and lowering their mortgage debt over time.
• Put down a large amount when you purchase a home. Coming up with a big down payment on a home is the best way to avoid negative equity in the short term. If you can save up 20% of the property's value or more, you’re much less likely to experience negative equity as a homeowner.

Can I correct negative equity?

If you do wind up with negative equity in a property you own, delaying selling the property can help you prevent losing money right away.

"Homeowners can repair negative equity simply by continuing to pay their mortgage and waiting for the market to recuperate," Satas said, adding that this is the usual course of action.

Other ways to fix negative equity include the following:

• Making additional mortgage payments. When you add additional funds to your mortgage payment, that money goes directly toward the principal of the loan balance. As a result, making extra mortgage payments can help you pay down a home faster and build more home equity.
• Improve your home's value. Making improvements to a home can increase its value and homeowner equity as a result. According to cost versus value figures from Remodeling Magazine, some of the top remodeling projects for return on investment include garage door replacement, adding manufactured stone veneer and a minor kitchen remodel.

Homeowners with negative equity may wonder if refinancing their mortgage can help. However, refinancing a home loan can be tricky or impossible when you have negative equity, mostly because lenders want to ensure they're not lending more for a home than it’s worth.

That said, there are several programs that can help homeowners with little or negative equity refinance when they’re in distress. These programs include the Freddie Mac Enhanced Relief Refinance, the Fannie Mae High Loan-to-Value Refinance Option, and the streamline refinance for FHA, VA and USDA loans.

» MORE: How often can you refinance your home?

Bottom line

Having a mortgage for an amount that’s higher than your home's value may make you feel uneasy, but it may not be a big deal if you plan to stay in the property for several years or more. Housing values tend to rise over time, and making payments on a mortgage will lower the amount you owe with each passing month.

In other words, many negative equity situations ultimately fix themselves.

That said, you have options if having negative equity is stressing you out. The easiest is making more than the minimum mortgage payment each month. This extra money you pay can be applied directly to your mortgage balance, saving you interest and helping you build equity much faster than you would otherwise.