By Jason Given · May 2026 · 9 min read
Most people going through separation assume the family home will have equity. They expect the property to be worth more than what is owed on it, and that the difference will be divided as part of the settlement. But that is not always the case. If property values have fallen since you purchased, or if you borrowed heavily at the peak of the market, you may find yourselves in a position where the mortgage exceeds the current market value of the home.
This is called negative equity, and it changes the nature of your property settlement significantly. Instead of dividing an asset, you are dividing a liability. While this adds complexity, it does not mean you are without options. It means you need careful planning and the right professional guidance.
General information note: This article is general in nature and does not constitute legal, financial, or credit advice. Separation involves complex legal and financial matters specific to your individual circumstances. Always seek independent legal and financial advice before making decisions.
What negative equity actually means
Negative equity occurs when the outstanding balance on your mortgage is greater than the current market value of the property. For example, if you owe $520,000 on a home that is now valued at $480,000, you have $40,000 in negative equity. The property cannot be sold without leaving a shortfall that someone needs to repay.
This can happen for several reasons. The property market may have softened since you purchased. You may have borrowed at a high loan to value ratio with a small deposit. Interest capitalisation during a period of financial stress may have increased the loan balance. Or renovation loans may have been drawn down without a corresponding increase in the property value.
Whatever the cause, the practical reality during separation is that the property cannot be sold without both parties needing to cover the shortfall. And neither party can easily refinance the property into their sole name without addressing the gap between the loan and the value.
How negative equity affects your property settlement
In a standard property settlement, the equity in the home forms part of the asset pool that is divided between the parties. When equity is negative, the property is not an asset at all. It is a liability. This means it still needs to be accounted for in the settlement, but the conversation shifts from who receives the equity to who carries the debt.
The Family Court considers all assets and liabilities when determining a just and equitable settlement. A property in negative equity does not disappear from the equation. It is weighed alongside superannuation, savings, vehicles, other debts, and the future earning capacity of each party. Your family lawyer will advise on how this affects the overall split in your specific circumstances.
It is essential to understand that both parties remain jointly and severally liable for the mortgage until it is formally discharged or refinanced into one name. Your lender does not care about your separation agreement or Consent Orders. If the loan is in both names, both people are responsible for every repayment. If you want to understand more about this joint liability, see our guide on what happens to the mortgage when you separate.
Your options when the property is in negative equity
Option 1: Sell the property and split the shortfall
If the property is sold for less than the mortgage balance, the remaining debt needs to be repaid. This is sometimes called a short sale, and in most cases the lender needs to approve it in advance. The shortfall becomes an unsecured personal debt that both parties are responsible for unless the settlement agreement specifies otherwise.
Your settlement agreement or Consent Orders should clearly specify how the shortfall is divided. For example, both parties might agree to split it equally, or one party may absorb a larger share as part of a broader asset division that accounts for superannuation or other financial resources. Your family lawyer structures this as part of the overall settlement.
Selling provides a clean break. Both parties walk away from the property and its ongoing costs, which can be emotionally and financially valuable even though a debt remains. The shortfall amount is typically lower than the ongoing cost of holding a depreciating asset indefinitely.
Option 2: One party takes on the property and the debt
In some cases, one party may want to keep the property despite the negative equity. This might make sense if they believe the market will recover in a reasonable timeframe, if the property is close to schools or family support, or if renting an equivalent home would cost more than the mortgage repayments.
If one person keeps the property, they are taking on a liability rather than receiving an asset. This is typically offset elsewhere in the settlement. For example, the party keeping the home and its negative equity might receive a larger share of superannuation or other assets to compensate for absorbing the debt.
The practical challenge is that the departing party still needs to be removed from the mortgage. Refinancing into one name with negative equity is extremely difficult because lenders require adequate security. The loan to value ratio needs to be within their acceptable range, and a property in negative equity has an LVR above 100%. You may need to wait until the property value has recovered, or bring additional funds from savings or family assistance to bridge the gap before a lender will approve the refinance.
Option 3: Negotiate with the lender
If you are experiencing financial hardship as a result of the separation, most lenders have dedicated hardship teams that can offer temporary relief. This might include a reduced repayment arrangement, a temporary interest only period, or an extension of the loan term to reduce monthly payments.
In rare cases, lenders may agree to accept a short sale and write off a portion of the remaining debt. This is not common and usually only happens when the lender believes the alternative, such as repossession and forced sale, would result in a worse outcome for them. A mortgage broker can help you understand your lender's hardship policies and approach the conversation in the right way.
Option 4: Wait for market recovery
If both parties can afford to continue servicing the mortgage, it may make sense to wait for the property market to recover before selling. Property values in most Australian capital cities have historically trended upward over medium to long timeframes, although past performance does not guarantee future results and some locations can take years to recover.
The practical difficulty is that waiting ties both parties financially to each other for an indefinite period. Both remain on the mortgage, both are affected by the debt when applying for new lending, and both need to agree on maintenance, insurance, and rates. If the relationship is difficult, this can be an emotionally taxing arrangement. Your settlement agreement should clearly set out who is responsible for repayments, upkeep, and insurance during any holding period.
There are also legal time limits to be aware of. In Australia, married couples have 12 months from the date of divorce to file for property settlement, and de facto couples have two years from the date of separation. If you are holding the property and waiting, ensure your legal agreements are finalised within these windows. See our guide on time limits for property claims after separation for more detail.
Not sure which option suits your situation?
A 30 minute conversation with Jason can give you a clear picture of your property position and what options are realistic.
Book a confidential chatHow negative equity affects both parties' borrowing capacity
Whether you keep the property or not, negative equity affects your ability to borrow going forward. The impact depends on which path you take.
If you keep the property: Lenders will assess the current loan to value ratio. A property in negative equity has an LVR above 100%, which is outside the lending criteria of virtually every lender. You will not be able to refinance, access equity, or restructure the loan until the LVR improves to an acceptable level, typically below 80% to 90%. This means you may be locked into your current lender and loan terms for an extended period.
If you sell and carry the shortfall debt: The remaining personal loan or arrangement will appear on your credit file and reduce your borrowing capacity when you apply for a new home loan. Lenders assess all existing debts when calculating how much you can borrow. A $40,000 shortfall debt could reduce your borrowing capacity by $150,000 or more depending on the repayment terms and the lender's assessment rate.
If the joint mortgage remains in both names: Lenders treat the full mortgage repayment as your ongoing commitment, even if your settlement agreement says the other party is making the payments. Until the mortgage is formally discharged or refinanced out of your name, it counts against your borrowing capacity in full. Our solo borrowing calculator can give you an indication of what you might be able to borrow on your own income once the joint debt is resolved.
Protecting your credit score during this period
Negative equity becomes a credit issue when repayments are missed. If either party stops paying the mortgage and payments fall behind, both parties' credit files are affected. Even one missed payment can remain on your credit report for five years and significantly impact your ability to borrow for a new home.
If you are struggling to meet repayments during separation, contact the lender's hardship team before you miss a payment. An arrangement made proactively is far less damaging than a default. If your partner has stopped contributing to repayments and you cannot cover the full amount alone, speak with your broker and lawyer immediately about your options. For a detailed guide on maintaining your credit, see how to protect your credit score during separation.
Getting an accurate picture of where you stand
If you suspect or know that your property is in negative equity, it is critical to get a precise picture of your position before you start negotiating your settlement. This means obtaining a current property valuation from a qualified valuer, not just an online estimate. It also means requesting a precise loan payout figure from your lender, which includes any break costs, discharge fees, and accrued interest.
The difference between these two figures is your equity position. If it is negative, you and your lawyer need to factor this into the settlement structure. If it is close to neutral, a small shift in property value could change the picture entirely, which means timing matters.
You will also want to understand how the negative equity interacts with the rest of your asset pool. If one party has significantly more superannuation, that can be used to offset the negative equity being absorbed by the other party. If there are other properties, vehicles, or savings, the overall settlement can be structured to account for the fact that the family home is a liability rather than an asset. Our guide on how assets are divided in an Australian divorce explains this broader context.
When to seek professional advice
If your property may be in negative equity, speak to a mortgage broker and a family lawyer before agreeing to any settlement terms. A broker can confirm your current loan to value ratio, assess your refinancing options, and identify whether any lenders would approve a restructure in your circumstances. A family lawyer can advise on how the shortfall should be allocated in the settlement and ensure your interests are protected.
Getting financial and legal advice at the same time, rather than sequentially, makes a significant difference. At Lendology, we work alongside your legal team to ensure the financial plan and the legal agreement are aligned from the beginning. There is no point agreeing to keep the property in your settlement if the lending numbers do not work.
Negative equity does not mean you are stuck. It means the path forward requires more careful planning and the right professional support to navigate.
Frequently asked questions
What happens to negative equity when you separate?
Negative equity means the mortgage balance exceeds the property value. During separation, both parties remain liable for the debt. You need to agree on how to manage the shortfall as part of your property settlement, whether that means selling and splitting the remaining debt, one party absorbing it, or waiting for the market to recover.
Can you sell a property in negative equity during separation?
Yes, but the sale proceeds will not cover the full mortgage balance. The remaining shortfall becomes an unsecured debt that both parties are responsible for unless your settlement agreement specifies otherwise. You may need lender approval for a short sale, and both parties should agree on how the remaining debt is split.
Can I still refinance if the property is in negative equity?
Refinancing with negative equity is very difficult because lenders require adequate security and an acceptable loan to value ratio. In some cases, if property values recover or if you can bring additional funds to the transaction, refinancing may become possible. A broker who understands separation finance can assess your specific position and advise on timing.
