How to Get Out of Negative Equity

Negative equity arises when an asset’s market value falls below the outstanding balance of the loan secured by that asset. This financial situation can affect homes and vehicles. If the asset were sold, the proceeds would not be sufficient to fully repay the associated debt.

Understanding Your Negative Equity Position

You determine negative equity by subtracting the asset’s current market value from your current loan balance. If the result is a positive number, you have negative equity, indicating you owe more than the asset is worth. For example, if you owe $281,000 on a home now valued at $270,000, you have $11,000 in negative equity.

Cars are particularly susceptible to negative equity due to rapid depreciation, often losing value soon after purchase. For real estate, factors such as market downturns, purchasing during peak market conditions, or making a minimal down payment can lead to an “underwater” mortgage. Falling behind on payments can also increase the loan balance through accumulated interest and fees.

Direct Payment Strategies

Making additional payments directly toward your loan’s principal balance reduces negative equity. This accelerates the reduction of your outstanding debt, narrowing the gap between what you owe and the asset’s market value. Even small, consistent extra payments can decrease the total interest paid over the loan’s lifetime and shorten its term. For instance, adding $100 to a monthly mortgage payment could shorten a 30-year loan by more than four years and save over $26,500 in interest.

To ensure extra funds are applied correctly, specify that the payment is for principal reduction. Lenders typically apply regular payments first to interest and then to principal, but additional amounts can be directed solely to the principal balance. This can be done by adding a fixed amount to each monthly payment, making an extra payment annually, or using financial windfalls like tax refunds or work bonuses. Confirm with your lender that they accept principal-only payments and that these are processed as intended.

A bi-weekly payment plan is another strategy for mortgages. Instead of 12 monthly payments, you make half of your monthly payment every two weeks. This results in 26 half-payments annually, equating to 13 full monthly payments over the year. This extra payment directly reduces the principal balance, leading to faster loan payoff and interest savings over the mortgage term.

Selling an Asset with Negative Equity

Selling an asset with negative equity means the sale price will likely not cover the remaining loan balance. This requires the seller to pay the difference at the time of sale. Without covering this shortfall, the lender will not release the lien, preventing the transfer of ownership.

Selling a Vehicle with Negative Equity

If you trade in a car with negative equity, some dealers may offer to roll the outstanding balance into your new car loan. This increases the total amount borrowed for the new vehicle, immediately placing you in negative equity on the new loan. This practice can lead to a cycle of being “underwater” on successive car loans, incurring more interest and higher monthly payments. Paying the negative equity out of pocket avoids compounding the debt.

Selling Real Estate with Negative Equity

Selling a home with negative equity often involves a “short sale.” A short sale occurs when a homeowner sells their property for less than the amount owed on the mortgage, with the lender’s approval. This process typically requires demonstrating financial hardship to the lender, who must agree to accept less than the full loan balance.

The lender must approve the sale price, and they may or may not forgive the remaining deficiency balance after the sale; in some cases, they can pursue a “deficiency judgment” requiring the former homeowner to pay the difference. Short sales can be lengthy, often taking several weeks to months, and they negatively impact credit. Alternatively, a homeowner can bring cash to closing to cover the difference between the sale price and the outstanding loan balance, enabling a traditional sale.

Refinancing Options

Refinancing can manage debt, but it typically requires the borrower to have positive equity in the asset. Most traditional lenders prefer a loan-to-value (LTV) ratio below 80% for mortgage refinancing, meaning the loan amount should be no more than 80% of the home’s value. However, specific programs or lender accommodations may exist for those with negative equity, particularly for mortgages.

Some government-backed loans, such as certain FHA streamline refinance options, may offer more flexible LTV requirements for existing FHA borrowers who are current on their payments. For both auto and mortgage loans, even if direct negative equity refinancing is not widely available, refinancing to a lower interest rate or extending the loan term can indirectly help. Lower monthly payments free up cash flow, which can then be applied as additional principal payments. Lenders will still evaluate criteria such as credit score, income, and payment history. Refinancing can improve monthly cash flow or reduce interest over time, but it does not eliminate the negative equity itself; it merely restructures the debt.

Seeking Professional Assistance

When facing negative equity, seeking professional assistance can provide solutions. Financial professionals offer objective perspectives and specialized knowledge. They can help navigate debt management and explore options.

Credit Counselors: Often working with non-profit organizations, credit counselors can help individuals create budgets, develop debt management plans, and negotiate with creditors. They provide a clear understanding of your financial situation and outline actionable steps.
Financial Advisors: Financial advisors offer broader financial planning advice, including strategies for debt reduction, cash flow optimization, and long-term financial health. They can help prioritize debts and create a repayment strategy.
Real Estate Agents: Experienced in short sales, real estate agents possess the expertise to guide homeowners through selling a property for less than the outstanding mortgage.
Attorneys: Specializing in debt or real estate law, attorneys can provide legal counsel regarding options like short sales, deficiency judgments, or foreclosure avoidance. They can explain legal implications and represent your interests throughout negotiations.

When selecting a professional, inquire about their credentials, experience with negative equity situations, and fee structures.