Negative Equity

Last week we talked about home values, equity and how they impact your loan to value. In some situations it’s possible to actually owe more on your home than its worth. We don’t see this often in normal circumstances, but there are times when this happens and it’s never easy to deal with. Today we are going to talk about what negative equity is, things that may cause it and how it can impact your financial bottom line. 

A quick review from last week on Equity. Equity is the value of the home minus the amount you owe. It’s most common under normal situations for that amount to be a positive number and thats considered positive equity. 

When you owe more than the home is worth, its considered negative equity. You may know this from car loans. When you finance a vehicle and drive it for a few years and trade it in, the dealer or bank will let you roll your previous outstanding balance into the new loan. This means you may owe more on the new car than its worth. 

It’s easy to get “upside down” in car loans, but not as common in mortgages. If you take out huge amounts of equity for improvements or worse, a fancy vacation or furniture, you impact your equity greatly. You now owe money on the house and the other items and holding your home hostage as collateral. 

If home values drop, rare but possible, or you need sell quickly, you may find there’s not enough equity in the home to satisfy the mortgage, and you’ll have to provide cash at closing to not end up short. This could result in the need for a short sale, which we will cover in a later episode. 

You could also end up in trouble if your equity isn’t very high when you want to sell and fail to calculate the additional commission fees, taxes and and attorney fees associated with selling a home. If there’s no equity you won’t have enough money to cover your cost of selling. 

It’s for these reasons, banks require an appraisal. They want to insure they aren’t loaning more on the property than they can get out if you default on your loan. The Dodd Frank Act prevents lenders from predatorily lending on a home knowing it places the buyer at unnecessary risk. We always suggest having a down payment and structuring your offer so you move into a home with instant equity. It’s a hedge against bad situations that can’t plan for. 10% or more, should give you enough equity for breathing room in case tragedy strikes.

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Chris Whitehurst

Berkshire Hathaway-RW Towne Realty 

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