When your home value falls below the amount you still owe on your mortgage, this is considered negative equity—or an underwater mortgage. There are many reasons a home can fall into negative equity, including damages to the property, a declining real estate market, or a high loan-to-value ratio. In many cases, negative equity is simply a byproduct of uncontrollable circumstances. But what happens when you need to sell your home? Here are several options to consider when selling a home with negative equity.
Understanding Home Equity
Home equity is the portion of your home’s value that you own outright. At the time of purchase, your amount of positive equity in your house is the amount of your down payment—typically around 20%. Your equity fluctuates, however, as you make mortgage payments and as the value of your home increases or decreases. The moment your home value drops below the amount you owe on your mortgage, you are in negative equity.
One of the most common causes of negative equity is a shift in the housing market and a sudden decrease in home values. This is what happened in the market crash of the past decade, resulting in more than 11 million homeowners—nearly 25% of mortgaged homes—with negative equity at its peak.
According to the latest statistics from CoreLogic, approximately 2 million homeowners—or 3.7% of all mortgaged properties—were experiencing negative equity at the end of 2019. While this is a positive trend from previous years, it still means that many homeowners are underwater on their loans and looking for the best ways to sell their negative equity homes.
Options for Selling Negative Equity Homes
The U.S. Department of Housing and Urban Development describes negative equity as having multiple consequences for both homeowners and the surrounding community. Foreclosures are a significant byproduct of homes falling into negative equity. As homeowners find themselves trapped in homes they can no longer afford, they choose to walk away and let the home fall into foreclosure.
This has a negative impact on a homeowner’s credit—and stays on your credit report for 7 years—but it also impacts the community. Other home values begin to drop as neighboring houses fall into foreclosure.
But there are options other than foreclosure when you find yourself with negative equity. These are some of the most common ways to sell your home when you owe more than your home’s value.
Pay the Remaining Mortgage
By far the simplest option for selling a home with negative equity is to get as much as possible from your home sale and pay the remaining mortgage yourself. If you owe $200,000 on your home loan and sell your house for $175,000, you can pay the remaining $25,000 at the time of closing. While this is the most expeditious way to sell a home with negative equity, it is not always a practical solution for homeowners. If you are experiencing the burden of negative home equity, it may also be an unreasonable financial burden to pay off your existing home loan. If that is the case, there are other options for selling your home.
If your home value has dropped below the amount you owe, and you are far enough behind on mortgage payments that you are unable to catch up, some lenders will agree to a short sale. With a short sale, the lender is willing to accept less for the home than your remaining mortgage balance. Lenders opt for short sales when they wish to avoid the process of foreclosure and feel that they can possibly recover more of the loan than they would through other methods.
The first step to a short sale is to speak with your lender and work out a short sale agreement. The process can often take longer than a traditional sale, and ultimately it is the lender—not the seller—who approves or denies offers on the home. For many homeowners trying to sell a home with negative equity, short sales are a desirable alternative to foreclosure. It is important to note, however, that once completed, a short sale can remain on your credit report for up to four years.
Deed in Lieu of Foreclosure
Another option for selling a home with negative equity is to not sell it all, but rather sign the deed over to the lender. Much like a short sale, this option requires the express involvement of the lender and is often only considered if there are no other liens on your property.
This course of action will negatively impact your credit score in the same manner as a short sale but is also often considered a better alternative to foreclosure. If the bank does agree to accept your deed in lieu of foreclosure, it is important to understand your rights as well as the rights of your lender. Some states have protections in place that prevent lenders from pursuing the loan deficiency—the difference between the home value and the amount you owe—after a deed in lieu of foreclosure, but not all. As you work with your lender to find the best solution for your situation, be prepared to work out an agreement in which you are forgiven the loan deficiency regardless of how much the home is worth.
Navigating Negative Equity
Negative equity is not always something a homeowner can control, particularly when the real estate market fluctuates unexpectedly. Managing the sale of a negative equity home can be challenging, but accessing support from a real estate agent can help you navigate your options.
If selling your home is a necessary step, understanding the current real estate market can also help you decide which solution is right for you. ProspectNow offers a comprehensive view of the housing market and predictive analytics to help sellers make better real estate decisions regardless of negative equity.