Adil Hussain

Negative equity occurs when the value of your home is less than your outstanding mortgage balance.

It makes it difficult to sell or remortgage creating a financial trap that can be difficult to escape.

50,000 homeowners in the UK have fallen into negative equity over the last 12 months due to falling house prices*.

Negative equity is borne out of the unequal risk-sharing burden of interest-based loans.

All of the burden falls on the borrower. If anything the bank that lent you the mortgage in the first place will benefit further by charging you higher rates!

This demonstrates the need for genuine risk-sharing models. A genuine partnership-based (i.e. Musharakah) model where a homebuyer and investors purchase homes together on an equity basis and share risks equally.

How To Avoid Falling Into Negative Equity

1. Don’t take a loan

The most straightforward way to avoid negative equity is not to take a mortgage in the first place.

If possible, consider alternative ways of purchasing a property, such as saving up enough to buy outright or seeking family support via interest-free loans or gifts. Additionally, consider looking for homes in cheaper areas or compromising on the space you want. This isn’t ideal but given the objective is to avoid interest, this would be a noble compromise.

While this may not be feasible for everyone, it completely eliminates the risk of falling into negative equity.

2. Use genuine risk-sharing products

Consider financial products that involve risk-sharing rather than interest-based loans.

Mortgages are one-sided products that leave the homebuyer exposed to most if not all of the risk. Islamic finance, for example, offers partnership-based models like Musharakah where the risk is shared equitably between the buyer and the financier.

There is a lot more to say about the contribution of mortgages to an unstable volatile housing market that increases the likelihood of negative equity but I will leave this for a future post.

3. Buy with a large deposit (at least 20%)

If you do decide to take out a mortgage or a partnership-based alternative, aim to put down a large deposit—ideally 20% or more.

A larger deposit means you’re borrowing less and have a greater equity cushion in case property values decline. This not only reduces your monthly payments but also minimizes the risk of slipping into negative equity if the market takes a downturn.

4. Don’t overpay above the true market value of a house

Be cautious not to overpay for a property. The housing market can be unpredictable, and paying more than the current value of the property increases the risk of negative equity. Always get an independent valuation and compare similar properties in the area to ensure you’re paying a fair price.

This also highlights one of the benefits of a partnership-based model to purchase houses. The co-investors in the deal are more motivated to ensure that the proposed deal they are getting into is viable because they also share in the risk of the venture.

What To Do If You’re Facing Negative Equity

Unfortunately, some of you reading this may already be facing negative equity. If you find yourself in this situation, here are some practical steps you can take to manage and eventually overcome it.

1. Make dua

As Muslims, we have access to a powerful tool that we don’t utilize enough—dua. Dua is a powerful tool that we can use to ask for relief from debt, an increase in our rizq, and barakah (exponential increase) in our finances.

In the Quran, Allah SWT says:

“When My servants ask you ˹O Prophet˺ about Me: I am truly near. I respond to one’s prayer when they call upon Me.” (Al-Baqara 2:186).

There’s an excellent article on Amaliah that covers 8 specific duas for wealth, provision, debt relief & other money problems.

2. Wait for the market to recover

Negative equity often occurs during market downturns. If you’re not in a rush to sell, consider waiting it out. Housing markets generally recover over time, and as property values increase, you may eventually return to positive equity. Patience can be key in such situations.

3. Try to find lower rates

If you’re stuck with a high-interest mortgage, shop around for better deals. Refinancing your mortgage to a lower interest rate can reduce your monthly payments and slow down the growth of your negative equity. Be sure to consult with a financial advisor to understand the costs and benefits of refinancing in your specific situation.

Also ideally if you’re in a mortgage, you should seriously consider refinancing with a more shariah-compliant alternative.

4. Make overpayments to reduce your principal amount

If your mortgage allows it, making overpayments can help reduce the principal amount you owe. This can gradually bring you out of negative equity, especially if property values begin to rise again. Even small, regular overpayments can make a significant difference over time.

Also generally speaking, making overpayments can be a financially savvy move. It reduces the time in debt and the amount of interest you have to pay, which will not only be good for your mental state and your wallet but also for your spiritual wellbeing.

Final words

Negative equity is a serious issue that can leave homeowners trapped in a difficult financial situation. With falling property values and the unequal burden of interest-based loans, more and more people are finding themselves in this position. However, there are steps you can take to avoid negative equity, and if you’re already facing it, there are practical ways to manage and overcome it.

Islamic finance, when done correctly, has the potential to address the problem of negative equity and, more importantly, tackle the underlying issue of creating an economy built on interest. By embracing fairer financial models and making wise financial decisions, you can protect yourself from these risks.

For more insights on how to navigate these challenges and explore the benefits of Islamic finance, be sure to subscribe to stay updated with future posts.

*Source: National Institute of Economic and Social Research (NIESR)