Negative Equity

Negative Equity

What is negative equity?

Negative equity (also called an underwater mortgage) occurs when a property’s market value is less than the outstanding balance on the mortgage secured by that property. In other words, you owe more on the loan than the house is worth.

Key takeaways

• Negative equity = property market value − outstanding mortgage < 0.
• Common after falling home prices (housing-bubble burst, recession).
• It limits options: selling, refinancing, and moving can become costly or impossible without covering the shortfall.

How it works

Home equity is the portion of a property’s value you own free and clear: current market value minus any liens or mortgage balances. Equity increases when:
* You pay down the mortgage principal, and/or
* The property’s market value rises.

When market value falls or you borrow more against the home than it’s worth, equity can turn negative.

Calculating negative equity (example)

1. Determine current market value.
2. Determine outstanding mortgage balance.
3. Subtract mortgage balance from market value.

Example: Sally bought a $400,000 home with a $360,000 mortgage. Years later she owes $340,000, but the house is worth $300,000.
* Current market value: $300,000
* Outstanding mortgage: $340,000
* Equity: $300,000 − $340,000 = −$40,000 (Sally has $40,000 in negative equity)

If she sold the house for market value, she would still owe the lender the $40,000 difference.

Implications

For the homeowner

• Selling the home may require bringing cash to the closing to cover the shortfall.
• Refinancing or obtaining a home equity loan/HELOC is often not possible.
• Missed payments can lead to credit damage, default, and foreclosure.
• Negative equity can reduce geographic and career mobility because selling incurs losses.

For the economy

• Higher defaults and foreclosures hurt lenders’ balance sheets and reduce bank lending capacity.
• Reduced household wealth lowers consumer spending, slowing economic growth.
• Severe, widespread negative equity (as in 2007–2008) can contribute to financial crises and recessions.
• Governments may face higher costs for mortgage relief programs and increased unemployment support.

Special considerations

• Underwater mortgage = another term for negative equity.
• Mortgage equity withdrawal (borrowing against home equity) lowers your net equity but is not the same as negative equity unless the new liabilities exceed the property value.

How to avoid or reduce the risk

• Make a larger down payment at purchase.
• Buy within your means and consider conservative price margins.
• Maintain an emergency fund to avoid missed payments during income shocks.
• Make extra principal payments when possible.
• Consider shorter loan terms or fixed-rate mortgages to reduce interest-rate risk.
• Invest in cost-effective home improvements that increase market value.
• Monitor market conditions and act early if values decline.

How to check whether you have negative equity

1. Get a current market-value estimate (appraisal, broker opinion, or reputable online estimates).
2. Check your latest mortgage statement for the outstanding principal balance.
3. Subtract the mortgage balance from the market value; a negative result indicates negative equity.

Bottom line

Negative equity means you owe more on your mortgage than the property is worth. It reduces financial flexibility, can complicate selling or refinancing, and—if widespread—can have significant macroeconomic consequences. Prevention focuses on prudent borrowing, adequate down payments, and maintaining a financial buffer.