What Is Negative Equity?

Negative equity are two words that no homeowner wishes to hear.

In good times, a property can be purchased and as the price rises, value or equity is created. Any loan or mortgage held against the property will be of a fixed or reducing value as payments are made, whilst the property increases.

This middle number in between the value and the debt would initially have been created by a deposit used to secure the property and mortgage by the purchasers. As it grows, so does their portion of ownership.

However, in times when a housing market is not 'rosy', they opposite can happen.

The value of a property can fall below the amount of debt or mortgage owed against it. Suddenly, a borrower might owe - for the sake of example - $100,000 on a property that is now only worth $90,000. This means that the borrower cannot simply sell the property because to do so would still require extra funds being found.

Mortgage lenders are not keen to wipe out debts against a property if it's value has fallen, simply to help a borrower in need. Since many of us would not be able to find an extra lump sum to make a sale possible, it can be impossible to sell or move for a number of years.

Whilst in theory, this may not sound like too great a hardship, for many it can be very bad. After all, a growing family that needs more space may be squeezed into a property for several years.

Property owners who are in negative equity will also find it difficult to purchase a second property. Lenders are not keen to make additional lending to couples with what may be a 'negative net worth'.

Residential property markets are cyclical. This means that in many respects they follow the fortunes of the wider national economy. In economic terms, residential property markets are pro-cyclical.

The effect of this is that borrowers who purchase a property at the top of the market - on the final upswing - will likely be in negative equity for several years to come. They will have the least affordable and highest cost property in the market. Inevitably, they are also often the people who can least afford it and got into the market too late thinking that it was a 'sure thing'.

Oftentimes, once the market has started to fall, the economic portents will force central banks to try and reign in inflation in. To do this, they will use increased interest rates. This will hit recent purchasers very hard and make it difficult for them to avoid property foreclosure (or repossession).