Fundamentally, negative equity is the situation where the value of your home is less than the amount you still owe on your mortgage. This can be a severe burden on you if you want to move and you find that your debts are greater than your selling price. These debts are the total of all securities on your home, including your mortgage, any second mortgage taken and any other loan secured on your property.
It will likely mean that you cannot sell your home until you have made up the difference. Negative equity can place specific restrictions on your ability to relocate. If you find better-paying employment elsewhere, you will be unable to sell your home until your negative equity has been cleared.
You Do Not Own Your Home
That is because you do not own the lien on your home until you have cleared your existing mortgage. If selling your home fails to achieve that, then you will not be permitted to do so by your lender. In effect, you do not own your home until your mortgage has been cleared. If you cannot pay off everything you owe on your property, then you are unable to convey title of the home to another person.
The loan is on the property not you, and does not travel with you. You can’t transfer negative equity or a second mortgage to your new home. It is therefore impossible for you to sell. You would need the lender’s agreement for this and you won’t get it!
Reasons for Negative Equity
The most common reason for negative equity is a decline in the housing market. Prices drop as homes become increasingly more expensive to purchase. This includes the need for increasingly higher down payments, closing costs and insurance costs. Some homeowners have made no or only small down payments, and negative equity starts almost immediately. Interest only mortgages have the same effect.
The problem with relying on house prices to rise is that fewer first-time buyers can afford them. This has the effect of depressing prices again. Appreciation of property investments is rarely a given! Don’t rely on it. So what should you do to avoid negative equity?
Avoiding Negative Equity on Your Home
Keep paying your mortgage on time. Never get behind, or the interest will increase and eat away at the amount you pay to the principal. Avoid interest only or deferred-interest payments unless you are sure of a lump sum payment later. You must also be certain that you will have no need to move home before that lump sum is available.
Making a good down payment and paying a regular sum to reduce the principal is the only sure way to improve the equity on your home. Starting off with positive equity is the best way to maintain it!
Finally, you cannot control what markets values do, but you can control how much down payment you put on down on a home. The more down payment you have to begin with, the more cushion you will have to prevent negative equity from occurring, should the markets turn down.