How to protect yourself against negative equity

With the spectre of recession hanging over the SA economy, there is some concern in the real estate industry that some SA homeowners could soon start to experience negative equity.

This occurs when the market or sale value of a home is lower than the outstanding balance on the owner's home loan. For example, if your original home loan was R1 400 000 and your outstanding balance is R1 350 000, but the market value of your home is only R1 300 000, you will have negative equity of R50 000.

You may find yourself in this situation if you borrow more than the price of the property at the time of purchase in order to cover transfer duty and other transaction costs, and are then forced to sell before the property value has had time to "catch up" to the loan value.

More commonly, though, it occurs when the economy goes into a recession, demand falls and home prices actually stop rising or go into a decline. And there is a danger of this happening if SA's economy contracts in the first quarter of 2023 as it did in the last quarter of 2022.

A period of negative equity may not be a big worry or even a long-lived problem for homeowners who are able to ride out a recession and wait for property prices to start rising more quickly when demand exceeds supply again as part of the normal property cycle.

But realistically, there is also a high level of employment uncertainty in SA's current scenario, and if you lose your job and are forced to sell your home when you are already in a negative equity position, you will not be able to sell it for the amount that you owe the bank.

And that means you will end up having to pay in the outstanding amount, at the time when you are least likely to be able to do so. You will also gain nothing from the sale of the property to put down as a deposit on another home - and could even end up having a debt judgment taken against you and losing your credit rating for several years if you are unable to pay what you owe.

Consequently, you should be doing whatever you can to avoid negative equity now, or to get out of that position as soon as possible. The best way to do that is to reduce the amount you owe the bank, and options include:

• Paying down your home loan. When interest rates are high, most of your monthly home loan repayment goes to pay off interest and not capital, especially in the early years of the loan. But if you can afford even a little more than the minimum monthly repayment on your home loan, it can really help you to lower the capital outstanding - and build up positive equity in your home. 

• Refinance your mortgage. If you can qualify for a lower interest rate, refinancing your mortgage may make good sense. It can help reduce your minimum monthly instalment and give you more leeway to pay extra into your bond account - and build positive equity more quickly.

• Talk to your lender. Most banks are happy to help customers in good standing try to find solutions to a home loan problem. You might be able to adjust your loan term to once again lower the minimum repayment required and put some extra towards paying off the capital.

Meanwhile, if you are currently in the market to buy a home, here's how to make sure you avoid negative equity:

• Research the market. Before you buy a property, work with a qualified and experienced local agent to research the market in the area you like and check recent sale prices, as well as rising or declining demand.

• Pay a deposit. Put down the biggest deposit you can afford. This will give you immediate positive equity in the home and reduce the size of the loan you have to repay at the current interest rates.

• Maintain your home. Taking care of your asset will help protect and increase its value over time, and protect you against negative equity.