Negative Equity

Your property is in a negative equity situation when the mortgage outstanding is greater than the amount you could sell it for in the open market. Every house price crash pulls the people who purchased their homes at the top of the property market into a negative equity situation.

But what can you do if you have negative equity on your home? It depends very much on whether you have a non-recourse or recourse mortgage. In some American states, all mortgages are non-recourse. This means that the mortgage holder is not personally liable for the debt. Instead the debt is tied only to the property. Therefore if a person with a non-recourse mortgage found themselves with negative equity (“underwater”), and they decided to return the keys of the property to the lender, their liability for the debt would cease. It’s the lender who takes the loss if they sell the property for less than the mortgage they lent out on. Lots of people are tempted to take advantage of this – but note that if you walk away from debt, you will find it extremely difficult to get another mortgage in the next seven years as the default will go into your credit report.

However if you are in a state where property loans are recourse mortgages, for instance states such as Pennsylvania and all of Europe, then you are personally liable for the mortgage. What does this mean? It means that if you return the keys of the property to the lender and they sell it for less than the mortgage, you still owe the lender the difference. You can see straight away that it’s just not worth walking away from the property if you have a recourse mortgage. If you walked away you would still owe money, and you’d have to find somewhere else to live, with all the expense that involves.

If you have a recourse mortgage and are in a negative equity situation, then you should do everything in your power to stick things out and ride out the downturn. Your best option is to try to overpay your mortgage if your loan agreement allows it – that way you reduce your risk, and save yourself a lot of interest payments in the future. Many people who have recourse mortgages feel hard done-by as they can’t just walk away from debt the way people in non-recourse states do. However, there is a silver lining. Because recourse mortgages discourage people from defaulting there is less forced selling of properties, which means that property prices don’t fall as much in recourse states as they do in non-recourse states.