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Negative equity―or being underwater―is when the value of property, such as your home or car, is less than the balance of the loan used to purchase it. Negative equity can be caused by factors that are out of your control, such as changes in the market, as well as those you may have control over, such as purchasing a home over asking price. If you find yourself with negative equity, there are actions you can take to get yourself back in the positive.
What Is Negative Equity on a Car Loan?
With your vehicle, negative equity is when you owe more on your car loan than your vehicle is currently worth.
Vehicles tend to depreciate rapidly, which means they quickly lose value after they are purchased. For instance, you might owe $11,000 on a car that's only worth $8,000 a few years after you bought it.
In addition to depreciation, factors that contribute to being underwater on a car loan may include:
- Having a long loan term and a high interest rate
- Making a small down payment or no down payment when you purchased the vehicle
- Having an accident that has lowered the value of the car
Because your insurance may only cover the current value of your vehicle and not the remaining balance on your loan, you might get stuck paying off the loan balance even if your car is a total loss from an accident or theft.
Example of Negative Equity on a Vehicle
- Your current car loan balance is $22,000
- Your car is worth $18,000
- You have negative equity of $4,000
If you want to trade in your car, you can choose to pay the remaining balance out of pocket, or the dealer may absorb the negative equity into a loan for a new car. When you roll over the negative equity into a new loan, however, it increases the monthly payment on your new car loan—and can lead to even more negative equity.
What Is Negative Equity on a Mortgage?
Like with a car loan, negative equity on a mortgage is the result of owing more on your home than its current market value. If you purchased your home with the expectation that its value would increase, it can be an unpleasant surprise to discover that the equity you have in your home may not be enough to pay off your existing mortgage.
Negative equity on a mortgage can result from a recession, a depressed economy or a housing bubble burst, like what happened during the mortgage crisis of the late-2000s. Essentially, any event that causes a drop in real estate values can cause homeowners to go upside down on their mortgage.
Other factors that can cause negative equity include:
- Taking out a home equity loan right before a drop in real estate values
- Buying a home when prices are overinflated
- Applying only a small part of the monthly payment towards the principal
- Making a small down payment
Example of Negative Equity on a Mortgage
- Your current mortgage loan balance is $330,000
- In the current market, your home is worth $300,000
- You have negative equity of $30,000
If you put your home on the market and it sells for $300,000, you'll have to pay the lender $30,000 to pay off your old mortgage or roll that amount into a new loan. Unfortunately, your lender may not offer you a new loan for more than 95% of what your home is worth.
Lenders use a calculation known as loan-to-value ratio (LTV) to determine whether you qualify for a loan and whether you will have to pay for mortgage insurance. Your LTV is lower when you have more equity in your home and vice versa. When your LTV is high, you pose a greater risk to mortgage lenders. If your LTV is 100% or higher, you have negative equity.
How to Get Rid of Negative Equity
There are several actions you can take to get rid of negative equity:
- Make additional payments. If possible, paying a little extra or making extra payments on your mortgage or car loan every month can help you get ahead.
- Refinance your loan. If your credit has improved, refinancing your mortgage or auto loan could qualify you for a lower interest rate. This can save you money on interest charges and allow you to pay off your loan earlier.
- Sell the vehicle or home yourself. Sometimes you can get more for your home or vehicle if you sell it yourself. You can also save on home sales commission by not using a real estate agent. However, for-sale-by-owner transactions can come with their own set of obstacles.
- Make home improvements. Upgrading a kitchen or bathroom, adding on an extra room or new porch, replacing your roof or finishing your basement can improve the value of your home and possibly put more money in your pocket when you sell. Improvements do cost money, however, and it may make more sense to instead put the expenses toward paying down your loan.
- Wait it out. If your car still runs or you don't have to move anytime soon, you may want to sit tight and hope the housing market improves and your car doesn't break down.
- Rent out your home, or a room. You could turn your home into a short-term rental for a couple months each summer, or year-round if you can find somewhere else to live cheaply. If you've remodeled your basement or have an extra bedroom, consider renting it out for extra income each month.
Make Negative Equity a Temporary Situation
While negative equity can be a cause for concern, you can make it temporary by taking action now. By increasing your payments, refinancing your loan or finding ways to increase your asset's value, you can transition to positive equity. Once you're out from being underwater, maintain positive equity by limiting financial decisions that can hurt your equity status.
Throughout the process of handling your negative equity situation, make sure you continue to make payments on time in order to protect your credit. You can sign up for free credit monitoring through Experian to keep a close eye on your credit and make sure it stays in great shape.