Paul's Insights: Managing the risk of negative equity

One of the most common factors used to be spending a fortune in home renovations, especially when they turned a modest house into the best in the street.

But it’s the downswing in the property market that’s driving the threat of negative equity today.

According to CoreLogic, prices in Sydney and Melbourne have dropped by 14% and 10% respectively since the market peaked in 2017. For anyone who got into the market with a small deposit, the possibility of owing more than their home is worth is very real.

On the plus side, the RBA says that over the past five years, the vast majority of home buyers purchased their home with a deposit of at least 20%. Since 2017 less than one in ten buyers have had a deposit below 10%.

This has helped to shelter the bulk of recent home owners against negative equity, with the RBA saying it’s an issue that affects only 2% of home owners nationally though some reports suggest a figure as high as 10%.

That said, negative equity is a big problem in some of the mining-driven areas of Western Australia, the Northern Territory and Queensland, where as many as 60% of home owners can be in negative equity.

The risk for lenders is that home owners are more likely to default on their mortgage when they have negative equity. The problem for Australians watching their home value decline is that the choice of options is limited.

You can choose to sell and recoup only a part of the cost of the property – in other words, take a loss.

Or you can hang onto your home and wait for market values to rise to the point where they catch up with your outlay. This could take time in the low inflationary times we live in. 

A third strategy is to make additional payments on your home loan. It can sound counter-intuitive to trundle extra cash into a loan when you’re sailing close to the wind with negative equity. But in our state capitals where values should recover and continue to rise over the long term, it can be a simple way of tipping the home equity scales back in your favour.

Paul Clitheroe is Chairman of InvestSMART, Chairman of the Australian Government Financial Literacy Board and chief commentator for Money Magazine.