What is Negative Equity?
Negative equity occurs when the current value of a property is less than the repayment amount outstanding on your mortgage. This will mean that you are, in effect, paying towards equity which is no longer there, known as 'negative equity.' When this happens, it is something that homeowners and property owners will likely have been be aware of and which is a daunting prospect for any property owner. Although not always discussed in depth, the repercussions of negative equity are important to property owners and the wider property and mortgage markets as well as the UK’s economy.
Negative equity makes remortgaging and moving house far more difficult. To understand what negative equity is in practice, what it means for homeowners and mortgage borrowers and the implications that come with it, mortgage borrowers need to understand how it works.
How Does Negative Equity Work?
Negative equity causes property owners to have to pay for property equity and value which no longer exists. For example, if a homeowner purchases a property for £400,000, with a 90% interest only mortgage, the value of their mortgage is £360,000. It is this amount plus interest which they will be repaying to their lender, having put down a deposit for the remaining £40,000.
If the property market is affected and property prices drop by 20% thereafter, the property will now be worth £320,000, or £80,000 less than the amount it was purchased for in the first place. The problem of negative equity arises, as although the property is not worth less, the borrower will stil ned to repay the original mortgage's balance. The homeowner and mortgage borrower is now in negative equity as they owe the mortgage lender more than they would receive should they sell the property.
What Does it Mean to be in Negative Equity?
Negative equity refers to a situation where a homeowner has taken out a mortgage on a property which then becomes worth less than the mortgage that was secured on it; if it happens, this means that the house is in negative equity.
An example of negative equity to illustrate the concept and provide further clarity on what it means in practice:
If for example you purchase a property for £180,000 and take out a mortgage worth £150,000. However, the very property you have purchased is considered now to only have a value of £130,000, this means that the house you have purchased is in negative equity. Ultimately, in such cases, still having to pay off the mortgage amount you agreed with the lender in the first place (as it is a secured debt), you will be paying off equity which doesn’t quite exist anymore: ‘negative’ equity.
However, if the house you bought was worth £180,000 and you took out a mortgage for £150,000 but the property then depreciates in value and is subsequently worth £160,000, it is not considered to be in negative equity, as the price is still above the mortgage value. However, what is worth considering is that if the value of the property falls, whilst you will not be in negative equity, you will in effect have a higher loan-to-value (LTV) with regards to your mortgage. This also means that you may be less likely to be able to acquire secondary finance, like a second mortgage.
What Happens if you go into Negative Equity?
You may be surprised to find out that not everyone who is in negative equity actually is even aware that they are in it at all.
The simplest way to find out if you are is to contact your mortgage lender to find out how much you owe at a specific point in time. After finding this amount, contact an estate agent or property valuer to receive a valuation for your home (or get a surveyor who will charge for this service.) If the valuation you receive from an estate agent ends up being lower than the outstanding mortgage amount then you may well be considered to be in negative equity.
What Are the Problems with Negative Equity?
There are a number of issues that can arise from negativity equity if you are a homeowner.
For example, if you are looking to sell your property in the not too distant future, you will encounter problems. This is mainly because you will need to repay the difference between the value of the property as well as the mortgage. You may find this difficult if you do not have savings in place to bridge this gap effectively and if there is a guarantor for your mortgage, they may be responsible if you cannot pay.
If you want to remortgage to get a fixed-rate or cheaper deal, you will also likely encounter difficulties as the majority lenders will not allow you to switch to a new mortgage deal if you are in negative equity until the necessary portion of the mortgage is repaid. What is more likely to happen is that once the existing deal ends, you will then automatically be moved onto the lender’s standard variable rate.
Can I Move House With Negative Equity?
Whether or not it will be possible for you to move home will depend on a few different variables. This includes things such as:
- If you are up to date with your current mortgage repayments
- The amount of negative equity you have
- How much is the property worth that you would like to move into
- The deposit you can raise for the new home
If you are looking to move sooner rather than later and are in this situation, you should always contact your lender first to see if they can help you, as failure to repay will impact your credit rating and therefore your chances of getting a future mortgage with bad credit. Depending on the lender, you may be able to benefit from a negative equity mortgage, which can allow you to transfer the negative equity you have into your brand-new home. Keep in mind that you will likely still be required to pay a deposit upfront.
Who Does Negative Equity Affect?
Unfortunately, there are many households across the UK who are struggling homeowners that have fallen into negative equity. There are approximately half a million properties in the UK that are classed as being in negative equity. However, it is thought that there are some areas that have a bigger problem with negative equity than others. In Northern Ireland for example, approximately two out of every five properties purchased after 2005 are considered to be in negative equity.
Can You Reduce Negative Equity?
There are a variety of ways you can look to lower the amount of negative equity you have in your home, including:
- If possible, make mortgage overpayments: check that you are allowed to do this with your lender and could otherwise incur an early repayment charge for doing so.
- Deciding to rent out your home: you will need to verify if this will be possible with your lender. You would still be required to pay your existing mortgage and you may need to pay a higher interest rate.
- If you are already struggling with arrears due to negative equity, it is recommended that you contact your lender directly as well as seek advice from one of the main debt advice charities in the UK.