Most homeowners don’t expect their house to depreciate when they buy it. Most real estate agents and other market experts say that homes appreciate, on average, about 3% to 5% depending on your local market, with an average of 4.3% since 1991 and 4.7% since 2000, according to FHFA. Even more recently, appreciation has climbed to 18.8% from April 2021 to April 2022. So with all that appreciation, how can you have a house in negative equity? Let’s first define a property in negative equity and read on to find out how this can happen and what to do about it.
What Is Negative Equity?
Equity on a home is the difference in the home’s value and what you owe on the loan for your home. Equity can also sometimes be referred to as your ownership steak.
When you first start paying on the loan for your home, the only equity you have is the down payment you placed when closing on the sale of your home. Unless you pay cash for your home purchase, you will start with a smaller amount of equity and grow to 100% equity. When buying, your equity generally starts from 3% to 20%. As you make continued payments on your property, you pay down the loan, thus increasing your equity.
When you own your home, you hope for continued appreciation of it, as mentioned above. Appreciation is set based on other sales of properties comparable to yours in your area.
Unfortunately, this doesn’t always happen. In times of economic downturn or when the housing market shifts, you may see no appreciation or, even worse, plummeting property values, causing depreciation. This kind of situation could leave you with negative equity. So if, at any point, your home has appraised for less than you owe, it would have negative equity. It is also referred to as an underwater mortgage or being upside down on your mortgage.
How Does Negative Equity Work?
Let’s work through an example to show further how negative home equity can affect you. Let’s say you purchase a house for $200,000. You put down $10,000 and take out a loan for the other $190,000. This would appear that you have about 5% equity. Now if your property value drops to $180,000, that would mean that you are now negative 5% equity.
There is nothing you can do to stop a drop in property value. Your local economy and home sales will be a driving factor for this. Even though you should pay attention to the value of your property, it will only affect you if you are looking to sell or refinance.
I Need To Sell! What Can I Do With My Negative Equity Home?
When you have a property with negative equity, you can deal with it in four ways. It all comes down to what you have available to spend, how soon you need to move, and what your lender will allow you to do. So let’s go over the four ways you can deal with negative equity and what kind of time frame you may need.
Pay The Difference With Your Negative Home Equity
You can always pay the negative equity if you need to sell your home and move immediately. By paying down the mortgage, you have lowered the loan vs. what is owed and made it a home with no equity, making it much easier to sell. Anything you profit from your home’s sale will go towards the existing mortgage.
Paying the difference is the quickest way to deal with negative equity when selling. You will have to consult with your lender to determine the amount needed and will want to inform the buyer of your property about selling with negative equity. The great thing about this option is that it is also the most straightforward. When you contact the lender to find the amount you will need to come up with, it will be the most you will ever need to come up with because you will continue to pay down the mortgage.
Force Appreciation And Improve The Property
Depending on your funds, you can improve the property and force appreciation on it. Improving the property and forcing appreciation is virtually the same formula investors use. So improving the kitchen and bathroom will cause the property to appraise for more, and even with little paydown on the loan, you’ll see an improvement in your equity. You can save some money by avoiding doing some upgrades to your home. It may be the amount you need to be able to sell.
This one will likely take the longest to finish as it takes time to find a contractor and get the work approved by the village so you don’t sell a home with unpermitted work. It also takes time for the contractor to do the job. All this has to happen before you even list the house to sell on the MLS with a top-notch agent to get the home sold for as much as possible and as quickly as possible. You may even walk away with extra money with good planning and an understanding of the market. It’s a gamble, but one you can take with a bit of guidance and help from the right people.
Wait Out Negative Equity On House
Waiting out future appreciation and waiting to sell is another option. Remember, the average appreciation is between 4% and 5%. So even if you have an upside down mortgage, your home value should climb back to the point that it’s worth more than your loan. While waiting for that, you’ll pay the balance and have a greater chance of equity sooner. It does take time and for some market shifts, but it even happened to those who lost about 30% of the value of their home during the Great Recession.
This process, unfortunately, takes the most time. Consider renting the property out while you move and purchase a new home. They will be paying down the mortgage while you wait for the appreciation. Renting the property out and waiting for a market shift may be challenging, but it will have the lowest cost and will eventually be the least amount of money you will have to come out of pocket.
Short Sale A House In Negative Equity
Short-selling a house will depend on your financial situation and lender. Sometimes the lender will allow you to sell the house for lower than the loan amount. This kind of sale is called a short sale. Banks try to refrain from doing it because they lose money by allowing it to occur. After a short sale, you may have to claim the difference it sold for vs. the amount owed on your loan, on your taxes as income, and they may also seek a deficiency judgment on you to recuperate the money they could potentially lose. You’ll want to seek proper legal advice from an attorney and financial guidance from a CPA.
A short sale is the least recommended way of dealing with an underwater mortgage on your house. There are other options, but this is the “less bad” of those options. As you can see, this process has many unknowns and solely depends on what the lender will approve. Even with an excellent short-sale attorney, it will take time to get it approved and get the sale closed. You’ll continue to lose money paying down the loan you may never recover.
Are These Really My Only Options For A House In Negative Equity?
Some investors use non traditional ways to buy a house. Companies like SILT Real Estate and Investments, LLC can purchase houses for cash or use a non traditional methods to help you sell a house. Only some homeowners can sell for cash. Using a non traditional way to buy a home is another way to deal with a property with negative equity.
Most investors don’t commonly use these methods and may have to use a specific process to make it happen. An example is letting the investor take over the property title so they can improve the property to force appreciation. Then the investor will sell the property. With this method, they take all the risks and hope for the rewards. With a technique like this, you will have to come out of pocket very little to sell your house with an upside down mortgage.
If you’re unsure if your situation may qualify for a non traditional home sale, contact us or fill out the short form below. We’ll be glad to talk to you about your situation and learn to see if there is a non traditional option for you.
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Can I Do A Negative Equity Refinance?
You may think you can do this because dealerships will do this with a car. I have yet to hear of a bank that will lend on more than the property is worth. A bank not lending for more than the property is worth is an understandable safety measure for the lender. Most banks will only lend for up to 80% of the value of the property. The only time you see that is for the purchase of a new home.
Final Word On Homes With Negative Equity
Owning a home valued for less than your loan on the house can be a problem. It’s only a problem if you want to move or refinance. You can always wait out the market and continue the paydown and appreciation to improve your equity position.
If you need to sell, fill out the short form below, and we can start helping you sell. It will not be a cash offer, but it will be quick and help you get out of the negative equity situation you find yourself in. If you have any questions, please call us at (708) 415-3801 or contact us here.
