What’s bigger: the outstanding balance on your mortgage or the market value of your home? Are you one of the growing number of Aussies that’s fallen into the negative equity trap and what can you do about it?
Negative equity refers to a situation where the outstanding amount on someone’s mortgage is greater than the value of their home. Simply put, it means if you sold your home for what it is currently worth and handed every cent from the sale to your lender, you would still owe money on the mortgage.
Damian Smith, CEO of RateCity says falling median house prices across the country mean we could be seeing more and more mortgage-holders slipping into negative equity.
"Some borrowers looking to refinance this year could be in for a nasty shock when they discover that a reduction in their home's value has turned back the clock on their mortgage situation,” said Mr Smith.
Those in negative equity tend to have taken out a home loan with a very high loan-to-value ratio (LVR) of 95%. With such a high LVR, it can be difficult switching to a new lender and refinancing for a lower interest rate.
The best advice for borrowers in negative equity is to make extra repayments to cut down the size of the debt. If that is too difficult, you can increase the frequency of your repayments without raising the amount of the debt you’re paying back.
Although it may require some self-discipline, you should direct any one-off cash receipts that come your way (such as a tax refund) towards paying off your mortgage.
For those on a variable home loan, the interest rate cuts by the Reserve Bank should ease the debt burden.
Before taking out a home loan, consider using a property assessor to get an idea of what your property (and the local area) is worth.
If you’re knee-deep in negative equity and unable to refinance your home loan now, Smith recommends researching the mortgage market, so that you can negotiate a more competitive rate with your current lender.
Some home loans come with a ‘no negative equity’ guarantee, which caps outstanding debt at the value of your home. This usually doesn’t come without terms and conditions.
MAKE SURE YOU NEVER FALL INTO NEGATIVE EQUITY
1. Borrow sensibly: avoid taking out a loan with a high LVR ratio (go for less than 90%) and put down a whopper deposit instead.
2. Make extra repayments: don’t just settle for making the minimum repayments. If you can, pay back larger sums or make your repayments more frequent. You’ll reduce your outstanding balance and swim out of the negative equity rip.
3. Don’t redraw on your mortgage: if you’re serious about paying off your home loan, it would be wise to not withdraw those repayments you made unless your miles ahead of your repayment schedule.
4. Avoid selling during a downturn: property prices dropped 3.5% nationwide in the year to September, according to Australian Property Monitors. Whilst it’s tempting to sell your home immediately, you’ll pinch yourself doing so if the property market is not strong. It’s best to wait for prices to pick up again.
-- By Stephanie Hanna