Negative equity can sound complicated, but the concept itself is fairly simple: it occurs when you owe more on your home loan than your property is currently worth.
Importantly, that is not the same as falling behind on your mortgage. You can make every repayment on time and still be in negative equity — a distinction that becomes particularly relevant as more Australians enter the property market with smaller deposits.
Recent comments from Assistant Immigration Minister Matt Thistlethwaite highlighted why that distinction matters. When asked about falling property prices and the risk of negative equity among borrowers with smaller deposits, he pointed to the fact that 99% of Australians were meeting, or were ahead on, their mortgage repayments as evidence they could not be in negative equity.
But keeping up with repayments does not determine whether you have positive or negative equity. When a senior government representative discussing housing policy conflates the two, it reinforces why homeowners need to understand what negative equity actually means.
For home buyers and homeowners, the more useful question is what negative equity could mean for your property, your home loan and the options available to you.
What is negative equity?
Negative equity happens when your outstanding home loan is greater than the current value of your property.
For example, imagine you buy a home for $600,000 with a 5% deposit.
You contribute $30,000 and borrow $570,000.
If your property’s value later falls to $550,000 while you still owe around $570,000, you owe approximately $20,000 more than the property is worth.
That is negative equity.
Your loan has not increased. The value of the property has simply fallen below the amount you still owe.
This is different from mortgage arrears.
Mortgage arrears mean you have fallen behind on your required loan repayments. Negative equity is simply about the difference between your loan balance and your property’s value.
You can therefore be financially comfortable, making every repayment on time and still technically be in negative equity.
Why smaller deposits can increase the risk
The size of your deposit affects how much equity you have in your property from the beginning.
Equity is simply the difference between what your property is worth and what you owe on it.
Using the same $600,000 property:
- A buyer with a 20% deposit borrows $480,000.
- A buyer with a 5% deposit borrows $570,000.
If the property’s value falls to $550,000, the buyer who borrowed $480,000 still has around $70,000 in equity.
The buyer who borrowed $570,000 may now owe more than the property is worth.
This does not mean buying with a smaller deposit is necessarily a bad decision. Government schemes that allow eligible buyers to purchase with deposits as low as 5% can help people enter the property market sooner.
It does, however, mean there is less of a buffer if property prices fall.
This is why buying a home should involve more than asking, “How much can I borrow?”
It is also worth thinking about how much you are comfortable borrowing, what savings you will have left after settlement and how your repayments would fit into your budget if your circumstances changed.
Does negative equity mean you’re in financial trouble?
Not necessarily.
For many homeowners, negative equity may have very little immediate impact.
If you are comfortably making your repayments, your income is stable and you do not need to sell or refinance, you may simply continue paying down your home loan as normal.
As you make principal repayments, the amount you owe gradually falls.
Your property’s value may also change over time.
This is why a fall in property prices does not automatically mean homeowners have lost money in practical terms.
The bigger issue is usually what happens if you need to make a change while your property is worth less than your loan.
When can negative equity become a problem?
Negative equity can create difficulties if you need to sell your property.
If your home sells for less than the outstanding mortgage, the sale proceeds may not be enough to repay your lender in full.
You could then need to contribute additional money to repay the loan, depending on your lender’s requirements, while also covering costs such as agent fees and other selling expenses.
This can be particularly difficult if you are selling because of unemployment, financial stress, illness, separation or another unexpected change.
Refinancing can also become harder.
When you refinance, a new lender will look at how much you owe compared with the current value of your property.
If you have very little equity, or are in negative equity, you may have fewer refinancing options. In some cases, you may need to reduce your loan balance before changing lenders.
That is why understanding your equity position early can be useful, rather than discovering there is a problem when you urgently need to refinance or sell.
If you are unsure how your property value or loan balance could affect your options, a broker can help you understand what may be available.
Why recent buyers can be more vulnerable to negative equity
Recent buyers can be more exposed to negative equity because they have had less time to build equity. The risk can be higher for buyers who purchase with a smaller deposit.
For example, on a $600,000 property, a buyer with a 20% deposit would borrow $480,000. A buyer with a 5% deposit would borrow $570,000.
If the property later fell in value to $550,000, the first buyer would still have about $70,000 in equity. The second buyer could owe around $20,000 more than the property is worth.
This does not mean buying with a small deposit is a bad decision. Schemes such as the Australian Government 5% Deposit Scheme can help eligible first home buyers purchase sooner with a smaller deposit. For eligible Adelaide and South Australian buyers, state-based assistance may also help with some of the upfront costs of buying a home.
It does mean there is less equity available as a buffer if property prices fall.
This is where loan-to-value ratio, or LVR, becomes important. LVR compares the size of your loan with the value of the property. A higher LVR generally means you have less equity in the property.
For Adelaide buyers, this is one reason it is useful to look beyond simply asking, “How much can I borrow?” Your deposit size, loan amount and property value all affect how much equity you hold.
How to work out your equity position
You can get a general idea of your position with two numbers:
- Your current home loan balance.
- An estimate of your property’s current value.
You can usually find your loan balance through your lender’s online banking or your latest home loan statement.
Online property estimates can provide a rough indication of your home’s value, although they are not formal valuations. Recent sales of similar properties in your area can also provide useful context.
Then subtract what you owe from your estimated property value.
For example:
If your home is worth approximately $750,000 and you owe $600,000, you have around $150,000 in equity.
If your home is worth approximately $550,000 and you owe $570,000, you are around $20,000 in negative equity.
You do not need to monitor your home’s value constantly. Having a general understanding of your position is usually more useful.
What should you do if you think you’re in negative equity?
For most borrowers, the first step is simply to understand your situation.
Check how much you owe and consider whether your repayments are still comfortable.
If your income is stable, you can comfortably afford your home loan and you plan to stay in the property, a temporary fall in value may not change anything immediately.
Maintaining some emergency savings can also provide additional flexibility if your circumstances change.
Your equity position becomes more important if you are planning to sell, refinance, move, buy another property or make a significant change to your finances.
If you are preparing to buy, it is also worth considering these risks before choosing how much to borrow.
A mortgage broker can help you understand how different deposits, loan amounts and repayments could affect your overall position.
Focus on the numbers that matter to you
Property headlines often focus on rising prices, falling prices and predictions about what might happen next.
For homeowners, the more useful information is usually much closer to home.
- Know approximately what your property is worth.
- Know how much you owe.
- Know how much equity you have.
- Most importantly, know whether your home loan remains comfortable for your circumstances.
Negative equity does not automatically mean you are in financial difficulty. But if your equity is limited, understanding your position early gives you more time to consider your options before you need to make a major financial decision.
If you are buying a home, considering refinancing or want to better understand your current lending position, speak with a Rise High mortgage broker.
We can help you understand your home loan, explore the lending options available and work through what may suit your circumstances.
Understand your home loan position
Whether you’re preparing to buy, reviewing your existing home loan or considering refinancing, chatting to the Rise High team can help you understand where you stand.
