If you're thinking about buying a home, you may be concerned about the prospect of negative equity.
Also referred to as being "underwater" or "upside-down," negative equity occurs when you owe more on your mortgage than your home is worth. While this situation isn't desirable, there are strategies you can use to try to avoid negative equity when you buy a home.
Technically, negative equity occurs when your loan balance is more than the current value of your home. For example, if you owed $130,000 on your mortgage, but your home was worth only $120,000, you would owe $10,000 more than your home's value. That $10,000 would be negative equity.
Negative equity isn't new. On the contrary, housing markets and home prices historically have been cyclical over long periods of time, and homeowners collectively have experienced negative equity throughout these cycles. When house prices rise, equity naturally expands; and when house prices fall, equity naturally shrinks. That's the nature of housing markets, and given that nature, temporary dips in equity can be expected to occur.
Negative equity has been more common in the current housing cycle because many people bought their home with a small or zero down payment or an interest-only or payment-option mortgage. In fact, more than 7.5 million U.S. homeowners were underwater on their mortgage and another 2.1 million had less than 5 percent equity in their home at the end of September 2008, according to a study by First American Corelogic, a real estate research firm.
Negative equity, or being underwater on your mortgage is a potentially dangerous financial situation because you may have greater difficulty refinancing your mortgage or selling your home.
Yet there are strategies that can help you maximize your equity and make it more likely that you’ll be able to avoid being underwater on your mortgage.
Here are five strategies to consider when buying a home:
● Shop for a home that's a good value for your area, so you'll be less likely to end up underwater if home values fall further.
● Make a hefty down payment, so you'll be starting out as a homeowner with an equity cushion in case home prices fall.
● Choose a traditional fixed-rate or adjustable-rate mortgage, so you'll be adding to your equity every time you make your monthly mortgage payment.
● If you opt for an interest-only or payment-option loan, pay more than the minimum payment each month, so you can reduce the likelihood of negative equity.
● Take a long-term view of homeownership. The longer you plan to own your home, the better positioned you'll be to ride out any dips in home values and the possibility of having negative equity.