What Happens When You Sell a Home You Have Negative Equity In?

These days, the average U.S. home is worth a little more than $334,000, according to Zillow. That's a 5% increase from a year ago.

But home values can fluctuate over time. And you might end up in a situation where you have negative equity in your home. 

While that's not a great boat to be in, it really only becomes a bigger problem once you have to sell your home. Here's what might happen in that scenario.

How negative equity occurs

When you have negative equity in your home, it means the amount you owe on your mortgage loan exceeds the amount your home is worth on the market. If you owe your lender $260,000 on a mortgage and your home can only sell for $250,000, it means you have negative equity. Negative equity can also be described as being underwater on a mortgage.

The reason you might have negative equity in your home is that you bought it when prices were high, but now, the market has cooled off. Let's say you paid $350,000 for your home and put 20%, or $70,000, down, leaving you with a mortgage of $280,000. 

Perhaps you've been paying into that mortgage for a bit of time so your loan balance is down to $260,000 (keeping in mind that a large chunk of your mortgage payments, especially early on, goes toward the interest portion of your loan). But if the market has declined a lot since your home purchase so that your home is now worth $100,000 less than what you paid for it, you could end up with negative equity.

When you need to sell with negative equity

If you sell a home with negative equity, you might end up having to dip into your own savings account to make up the difference. Let's say you owe your lender $260,000 on your mortgage but your home can only sell for $250,000. That means you could, in theory, take the $250,000 from your sale proceeds, supplement that with a $10,000 withdrawal from your savings, and call it a day. 

Of course, this is an imperfect example, because selling a home for $250,000 doesn't automatically mean walking away with $250,000. Even if you don't use a real estate agent, you might have to pay something in real estate transfer taxes. The point is to illustrate what might happen if you can't sell your home for a high enough price to pay off your mortgage in full.

But what if you don't have the money available to make up the difference? In that case, you could ask your lender to agree to a short sale, where it accepts the amount your home sells for as the sum that will satisfy your remaining mortgage obligation. 

Getting a lender to sign on for a short sale can be difficult, since it's agreeing to lose money. And a short sale could also negatively impact your credit score. But it is an option when you have negative equity and need to unload your home.

How to avoid ending up with negative equity

You can't necessarily predict when the value of your home will decline. And you can't always help having to sell at the wrong time. 

But one way to avoid a negative equity situation is to not overpay for your home. If the market heats up, sit it out until home prices come down. And also, don't make too small a down payment. The more money you put down at closing, the more immediate equity you get.