The property market is prone to change – and sometimes that involves drops in home values.
Refinancing when you don’t have equity or your property’s value has decreased does present some challenges, but it’s not impossible.
In this article we will explain how house prices dropping can impact your equity and your ability to refinance. We’ll also explain what negative equity is and what you can do if you fall into negative equity.
How declining house prices can impact your equity
Any homeowner whose property declines in value could find themselves with less home equity.
Home equity is the portion of your home that you own outright. You can work out your equity by subtracting your remaining home loan balance from your property’s value.
Equity can fluctuate over time since property values also fluctuate. Your property’s value is not the same as its purchase price.
Borrowers who have taken out large loans in the last couple of years while property prices have been sky-high could be even more susceptible to a drop in home equity.
Since interest rates are rising too, this can leave some borrowers in a ‘mortgage prison’, which can make it more difficult to refinance.
Declines in property values can affect homeowners differently depending on individual circumstances.
1. Owner occupiers
If you are living in your ‘forever home’ that you don’t intend to sell, it’s likely that you won’t be impacted too much by decreasing housing values.
However, if you’ve purchased an entry-level home that you intend to sell soon and move into something pricier, your plans might be interrupted by a fall in your property’s value.
Additionally, if you want to get cash out, you may have troubles. Decreasing property values results in you having less equity in your home to tap into.
2. Investors
If your investment plans involve owning an investment property long term and enjoying the rental income, falling property prices may not have a significant impact on you.
However, short-term investors could find themselves not making the profit they had hoped to by selling their property.
Similarly to owner occupiers, refinancing your investment home loan can become more complicated if your property value declines.
Can you refinance if your property value declines?
Although interest rates are on the rise, there are still competitive home loan deals out there.
Some homeowners might be thinking about refinancing to secure a lower interest rate. But what if your equity has dropped?
You can still refinance your home loan if your equity has dropped, but most lenders will require you to have at least 20% equity in your home.
Here are some of the requirements to refinance your home loan:
At least 20% equity in your home to avoid paying Lenders Mortgage Insurance (LMI)
Proof of your income and assets
Documentation of your existing home loan and any other debts
Proof of your expenses
Have a good credit score and reliable repayment history.
If you have less than 20% equity, you may need to pay LMI when you refinance. LMI covers the lender in case you default on your home loan.
How to refinance if your home has dropped in value
Now that we’ve established how property value declines impact homeowners differently and how this can affect refinancing, let’s look at some tips for refinancing:
Learn your property’s value: getting an accurate valuation tells you more about what your refinancing options could be. You can organise one independently or wait for the lender you approach for refinancing to organise one.
Establish why you want to refinance: your reason for refinancing will affect your ability to do so. Getting cash out may be difficult if your property has dropped in value, but you may be able to refinance for other purposes (e.g. debt consolidation, to switch between fixed and variable rates etc.).
Speak to a lender: figure out if refinancing is even an option by speaking directly to the lender you wish to refinance with. You may still be able to refinance if you are not in negative equity.
Speak to a mortgage broker: get an expert’s opinion on your refinancing options by speaking to an Aussie Broker. They’ll be able to tell you whether your refinancing goals are a possibility or whether it’s better to focus on increasing your home equity.
What is negative equity?
Negative equity means the value of your property is less than your outstanding home loan balance.
Let’s look at an example.
Say you purchased a home last year for $580,000 and you took out a $550,000 home loan.
Now, your home loan balance is $540,000. You decide you want to refinance your loan and a property valuation reveals your home’s value has declined to $535,000.
Because your home is now valued at less than your remaining home loan balance, you are in negative equity.
What can you do if you fall into negative equity?
Finding out you have negative equity in your property can be stressful, especially if you want to refinance your mortgage.
If you fall into negative equity, you likely won’t be able to refinance your property until your equity is at an acceptable amount.
There are two main ways to build up the equity in your property.
1. Pay off more of your home loan
Paying off more of your home loan, and faster, can be a good way to build up equity.
Some ways you can do this include:
Increase your repayment amount: even raising your repayment amount slightly can help chip away at your home loan faster
Make extra repayments: whether you make one-off, lump sum extra repayments or regular additional repayments, either can be helpful for paying off more of your home loan
Up your repayment frequency: increasing your repayment frequency from monthly to fortnightly gives you an extra repayment cycle each year, since there are 12 months but 26 fortnights per year.
2. Increase your property’s value
Some renovations can help add value to your home, which might help to boost your equity.
It’s important to do plenty of research and consider what renovations will be best for adding value to your property.
These could include:
Refreshing the kitchen: you might add an island bench, upgrade your appliances or add new tap fittings
Upgrading the bathroom: a tile refresh or new vanity could go a long way
Adding an outdoor space: if you have room, add some decking or a patio – bonus if it’s weather-proof
Constructing an extra bedroom or granny flat: this extra living space can add value to your home
Updating storage areas: ensuring ample storage space in your home can be helpful for adding value.
The difficult thing about attempting to increase equity and property value through renovations and home improvements is that it can require significant capital. And, if your equity is low – you might not be able to tap into it to help fund your projects.
What can you do if you’re unable to refinance?
If you’re unable to refinance because of your home equity, it can be frustrating.
While you build up your equity, there are some steps you can take to stay on top of your home loan.
1. Negotiate with your lender for a better interest rate
Are you hoping to refinance to a lower interest rate? While you wait for your equity to grow, it can pay to ask your lender for a better rate.
If you’ve been with your lender for a couple of years, chances are you’re paying a loyalty tax. This happens when existing borrowers are charged a higher interest rate than new borrowers.
An Aussie Broker can help negotiate a lower interest rate on your behalf.
2. Review your household budget
Conducting a review of your household budget can be beneficial if your home loan repayments are going up.
It could help to searching for areas where you can cut back while you wait to refinance.
You might ease off on takeaway dinners for a while, for example, or you might switch to a cheaper car insurance provider to save money.
3. Get help early if you need it
Your lender or a qualified financial adviser can walk you through your options if your home loan becomes hard to manage as you wait to refinance.
Don’t hesitate to reach out before you miss a home loan repayment.
An Aussie Broker can help you work out your home loan options. Just book an appointment at a time that suits you.