What Is Negative Home Equity?
Home equity is the portion of a property's value owned by the purchaser. Equity is earned by paying down the principal amount of the mortgage loan, not just the accrued interest. Negative home equity occurs when the principal amount exceeds the value of the property.
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Significance
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Homeowners with adjustable-rate mortgages are often the ones who find themselves in the grip of negative home equity, but those with fixed-rate mortgages are not totally in the clear. Due to circumstances such as rising interest rates, declining home values or failure to pay down the principal balance, many people may begin to owe more money on their mortgage than their house is currently worth.
Considerations
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Initial low-interest teaser rates eventually reset to current market rates, leaving many borrowers with the much higher market interest rates than they were originally given, sometimes more than double.
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Warning
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When borrowers with adjustable-rate mortgages are upside down on their loans, they may be unable to pay, sell their house, or refinance if interest rates rise. Declining home values could leave them without a way out, owing their lender sometimes tens of thousands of dollars more than their home is worth.
Effects
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Homeowners with negative equity are at constant risk of foreclosure. Especially when confronted with unexpected financial obstacles such as unemployment, death, divorce or medical challenges, borrowers who are underwater may be stuck without the means to pay their mortgage or the option to sell their house.
Prevention/Solution
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Those with positive equity should protect it by avoiding home-equity borrowing.
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