Young & Invested: What happens if property prices go backwards?
Could a generation of new buyers could be left trapped if the market turns?
Welcome to my column, Young & Invested, where I discuss personal finance and investing for Gen Z and Millennials.
This column aims to be a resource for young investors navigating an ever changing financial, political and social landscape as they try to build wealth. Tune in every Thursday for the latest edition.
Edition 54
To almost no one’s surprise, the Aussie housing market is still running hot.
Mortgage credit demand jumped 12.3% year-on-year, which is the strongest growth in nearly five years. Unsurprisingly, this has coincided with the Government’s expansion of the Home Guarantee Scheme in October last year, which allows every first home buyer (FHB) to purchase with a 5% deposit whilst avoiding Lenders Mortgage Insurance (LMI).
This was a move that was widely criticised by many, including myself. My main point of contention was that it was a disingenuous attempt to improve affordability, whilst reinforcing prevailing price appreciation in the absence of sound supply-side measures.
Whilst it might temporarily appease both existing and prospective homeowners, it’s hard to argue that it hasn’t led to a further deterioration in affordability. This becomes evident when we look at the average size of FHB mortgages, which have surged over 8% to a record high of $607,500 – far outpacing overall house price growth over the same period.
It is abundantly clear that neither side of the political spectrum currently has the stomach to make any sweeping, useful reform that would genuinely shift the affordability landscape.
With over 60% of Australia’s wealth currently tied up in property, any policy that nudges prices downward threatens to unsettle a very large constituency.
Beyond that, recent FHBs using the 5% deposit scheme are the most vulnerable, given they’ve had less time to build equity and are operating with higher leverage. Beyond this, a significant correction would also carry broader economic consequences for both homeowners and non‑homeowners.
Our Kiwi cousins across the pond are already feeling some of this pressure. After several targeted interventions to reduce house prices, their economy has contracted in three of the last five reported quarters. More locally, price momentum in Sydney and Melbourne look to have softened slightly. But the ever-present pressure on FHBs to get into the market as soon as humanly possible hasn’t eased.
Source: Metropole Property Strategists. 2026.
Amidst all this, there is one question that we tend to sidestep: what happens if house prices move backwards? I’m not here to debate policy or speculate on an impending crash, but at some point it’s hard to argue that pendulum won’t ever swing.
It’s no secret that the national home ownership rate has been falling, however we’re still at the level where over half of Aussies own a home. If this trend is to continue, eventually this dynamic will shift to a majority that do not own a home due to financial constraints. Once the scale has tipped towards non-owners, this may change.
I think it’s worth walking through what a downturn implies for a growing cohort of FHB holding highly leveraged property. The question isn’t whether a crash is on the horizon, but whether we fully understand the mechanics if prices move against us.
Why talk about this now?
If house prices move backwards and your outstanding loan balance exceeds the value of the property it is secured against, you’re considered to be in negative equity. For most established homeowners, the chances of falling into negative equity are slim given the extended period of strong appreciation we’ve seen.
For FHBs using the 5% deposit scheme, the starting point is a 95% loan‑to‑value ratio (LVR). That means almost the entire purchase price is borrowed, leaving only a thin buffer to absorb any price movement. A small decline in value can wipe out that buffer entirely.
For example, if I bought a unit for $500,000 with a $475,000 mortgage, I begin with 5% equity. If the market value of my unit falls 7% the next month, the property is now worth $465,000. If I haven’t paid down my loan balance much, I now owe more than what the home is valued at. The repayments remain the same, but on paper, I’ve technically slipped into negative equity.
Whilst the prospect of price reversal may seem irrational or unlikely, it was only a few years ago where prices experienced a significant national decline. A combination of slowing price growth, rising repayments and thinner equity buffers may change the game. It’s this perfect storm of sorts that leaves FHB more vulnerable to any price corrections.
While the RBA notes that less than 1% of Aussie borrowers are currently in negative equity, the risk is concentrated in recent buyers who stretched their borrowing capacity or entered the market with very small deposits.
Modelling from research house Roy Morgan, showed that mortgage stress had dropped to a 3-year low last December, but the RBA’s decision to raise rates recently with further hikes to potentially come, means mortgage stress is on the way up again.
The forecast below models the impact of the rate increase in February by +0.25% to 3.85% and a potential rate increase of +0.25% to 4.1% in March 2026. It is predicted that the rate rise will likely hit mortgage holders hardest in Victoria, Queensland, and Tasmania.
But what do rising rates and mortgage serviceability have to do with being in negative equity?
Whilst it’s not an automatically catastrophic situation, negative equity becomes an issue when something forces you to sell while your loan balance is higher than the value of the property. Rising rates and thus higher repayments are a common factor which push households closer to mortgage stress and the risk of being unable to hold onto the property increases.
What are the implications?
The first and most important effect is that your cash flow becomes critical. When the value of your home drops below the size of your mortgage, you lose the flexibility to take risks that might interrupt your income. This might come in the form of a career change, extended holiday or even an unexpected financial set back. Anything that disrupts your ability to meet repayments increases the risk of being forced into a sale.
The psychological side of negative equity is also often underestimated. It can be incredibly confronting to continue paying down a loan that exceeds the value of the home it’s attached to, especially if prices continue to fall. It’s fair to start wondering whether you should simply cut the losses and walk away. But selling in negative equity is hardly ever the first choice.
In the event the sale proceeds don’t cover the mortgage, the remaining balance generally becomes a personal loan. And because that loan is likely unsecured, the interest rates can be higher and you’re now repaying debt without the benefit of owning an asset. The real problems arise when you’re forced into a sale at a suboptimal time due to uncontrollable life events such as redundancy, illness or divorce.
Importantly, the First Home Guarantee is designed to protect the lender rather than the borrower. This only comes into play after a default, repossession and forced sale. It doesn’t prevent negative equity nor does it cover missed repayments and subsequent repossession. The lender is still entitled to pursue the borrower in the scenario where there is a shortfall after sale proceeds and other guarantee payments are applied, have been claimed and paid to the lender.
Although financial institutions often take a long-term view on house prices, being in negative equity also affects your broader financial flexibility. Banks become far more cautious about extending additional credit when your mortgage is already underwater. Additionally, borrowers in negative equity can face significant challenges in refinancing, meaning they’re trapped with higher rates even when the broader rate environment has improved.
Many FHB might fall into financial stress if rates continue to rise, however there are several steps taken before the bank repossesses your home. It’s difficult to prescribe a ‘best course of action’ as each individual circumstances will be different, but the sale of a property in negative equity is often seen as a last resort measure, especially if you can meet your repayments on an adjusted schedule. Even if prices stay flat, continuing to pay down the loan means your equity position will naturally improve over time.
Some grounding thoughts
One thing that often gets lost in the conversation is that not every borrower is equally exposed to the prospect of a reversal. Even with the 5% deposit scheme, banks don’t hand out loans based on optimism. The median combined capital city house price might be hovering around the $1 million mark, but that doesn’t mean someone earning $80,000 with a small deposit is getting approved for that amount. The bank simply won’t lend beyond what they believe you can realistically repay.
This is why many recent buyers (even those who entered with small deposits) may not be as poorly positioned. Plenty of households who bought with 5% deposits have already seen their equity improve. Perth is a good example where dwelling values rose around 7% in the three months to February 2026. For buyers in markets like that, it would take a decent correction to push them into negative equity. Sydney and Melbourne have been flatter, so the picture is more mixed, but even then, select borrowers have already built enough equity through repayments alone to sit comfortably.
Where the risk does start to creep in, is if interest rates rise sharply. Between 2022 and 2023, standard variable rates effectively doubled from 4.5% to almost 9%. That kind of increase forces households to allocate a much larger share of their post‑tax income to repayments. Fortunately, lenders do apply a serviceability buffer when assessing loans.
Mortgage broker and Director of Solve It Finance, Jason Tran notes that banks normally test a borrower’s ability to repay at a rate three percentage points above the actual rate offered. If your rate is 6%, the bank assesses whether you can afford repayments at 9% to account for future increases. The buffer is designed to protect borrowers from the kind of rate shocks we’ve seen in recent years. Further to this, when assessing feasibility, Tran says that if mortgage repayments exceed 45-50% of post‑tax income, borrowers are generally considered to be at ‘mortgage stress’ level.
Negative equity isn’t just about the paper value of your home. It creates significant financial risk, particularly in high-rate environments where your ability to refinance is hindered and you’re at an increased chance of defaulting. Those who’ve bought recently and started with a smaller deposit are most exposed to a potential dip in property values.
Thanks to Jason Tran, Director of Solve It Finance, for his insights.
