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What is negative equity and why is the RBA concerned about it?

Lucy Dean
·4-min read
Australian $50 notes, Australian houses from aerial view.
Here's what the RBA is talking about. Images: Getty

The Reserve Bank of Australia has indicated the coronavirus pandemic recession is over, but sounded the alarm over homeowners’ vulnerability should the economic situation worsen.

Appearing at senate estimates on Tuesday, the RBA deputy governor Guy Debelle said the Bank’s “best guess” is that Australia will return to growth in the September quarter.

However, in a separate speech on financial stability, assistant governor Michele Bullock said risks remain for homeowners.

In particular, Bullock warned of an increase in homeowners with negative equity.

What is negative equity?

Negative equity occurs when the value of a property falls below the balance remaining on the home loan.

Homeowners around the world lurched into negative equity during the Global Financial Crisis, with as many as 230,000 homes in Ireland alone falling below loan value.

And in that European nation, many homeowners are still clawing their way out 13 years’ later.

What’s happening to negative equity in Australia?

“Households have also been impacted by the pandemic-induced recession. Prior to the onset of the pandemic, household debt in Australia was already at a high level,” Bullock said.

“Provided households have the income to support servicing the debt, this is not a problem.

|But the onset of the pandemic-induced recession raises the possibility that some households will be unable to meet their repayments because their incomes have fallen, and so banks will experience an increase in non-performing loans.”

And while most households have been able – to some degree – to offset job losses with Government support and an increased savings rate, not all have been able to.

At the peak of home loan deferrals in June, around 8 per cent of homes were pausing repayments, with most now having picked up their repayments again.

But, Bullock added, there are still a “significant minority” of homes that hope to remain on deferred payments. Many of these homeowners work in vulnerable industries or are highly leveraged.

Due to this, the RBA expects non-performing loans to increase in the coming months.

“The impact on bank balance sheets of the rise in non-performing loans will depend on whether the value of the property is enough to cover the outstanding debt – that is, whether the borrower is in negative equity,” Bullock continued.

“If a loan is in positive equity, then the borrower has the option of resolving the situation by selling the property and repaying the debt. Only a very small share of loans are currently in negative equity, which suggests that losses to banks on housing loans will be limited.”

The problem is, if household prices fall significantly, that balance will shift.

Bullock said this isn’t entirely out of the question as population growth is set to remain weak, while the country’s economic recovery still remains hypothetical.

Additionally, nervous investors who see vacancy rates rising and rents falling could also begin selling, accelerating the house price fall.

What does negative equity mean for me?

You can find out if you are in negative equity by comparing your property’s value with the outstanding balance on your loan.

There are several calculators that offer valuation services, or you can see how much similar properties in your area are sold for, or speak to an agent to gauge the value of your property. Your outstanding balance should be on your latest statement, or you can just call your bank to find out.

If you’re in negative equity and need to sell, the bank will still want you to repay the full loan amount. They may ask for other funds to cover the shortfall with your savings or by selling other assets, and may also inquire about your spending habits.

Additionally, the bank will want to confirm that you bought the home in a legitimate sale and was not a related party sale, Mortgage Choice broker John Costa said in a Finder report.

Ultimately, the mortgage insurer will cover the shortfall.

However, there are alternatives to selling at a loss. While it’s difficult to refinance in negative equity, Costa said it’s worth considering if you can afford to make extra repayments to reduce the debt.

Homeowners can also ask for help if they’re suffering financial hardship or negotiate with their lender. Additionally, a solid renovation could add value to your property.

But it’s generally better to prevent rather than solve. Homeowners should make sure they get an accurate valuation of their property before they buy to ensure they’re not borrowing too much, and avoid borrowing too much.

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