Many homeowners fear falling into negative equity and the financial difficulties this can create. However, it is not always the disaster it appears to be, and the solution is often straightforward. We’ve provided answers to some common questions to help you understand and manage the situation.
WHAT IS NEGATIVE EQUITY?
If you’re in negative equity, it means that the current value of your home is less than the amount you owe to your mortgage provider. For example, if you bought a home worth £200,000, borrowing 90% of the value (£180,000) from a mortgage provider, if the value of your home fell quickly to £175,000, you would be in £5,000 negative equity.
HOW DOES NEGATIVE EQUITY HAPPEN?
Negative equity is usually the result of a sharp fall in the value of a property very soon after it was purchased. This can be because of a slump in the housing market. Falling house prices are typically the most common cause of negative equity. Other reasons could be if someone has taken a secured loan against their home in addition to the mortgage, for example, perhaps they borrowed an additional sum to consolidate other borrowing.
If someone has an interest-only mortgage, the outstanding balance doesn’t reduce as they make payments. This puts them at a greater risk of negative equity if their property value falls. If mortgage payment has been missed, then the outstanding balance could increase to a level higher than the property value. Ultimately, negative equity can often be caused by a combination of these issues.
HOW DO YOU KNOW IF YOU’RE IN NEGATIVE EQUITY?
If any of the above applies to you, you can find out if you’re in negative equity by asking for:
• The outstanding balance you owe your mortgage provider
• A property valuation from a local estate agent
If the outstanding balance is higher than the valuation, you’re in negative equity.
WHAT CAN YOU DO ABOUT NEGATIVE EQUITY?
You have several options to help you get out of negative equity. You can:
MAKE AN EARLY REPAYMENT ON YOUR MORTGAGE
This can reduce your outstanding balance to below the property value. Mortgage rates are often higher than savings rates and so you could use any disposable funds you may have to repay part of your home loan. However, this could be subject to a charge if you make an early repayment, so this may not always be an appropriate option.
INVEST IN HOME IMPROVEMENTS
In some cases, investing in an extension, new kitchen or garage conversion may increase the value of your home to above the outstanding balance on your mortgage. However, the cost of the home improvements could end up being more than the added value to your home.
WAIT FOR THE HOUSING MARKET TO IMPROVE
Negative equity is only really a problem if you want to sell your property, as there will be a shortfall in how much you need to repay your mortgage provider. Property market downturns are usually temporary so, if you can, simply wait to sell until house prices have risen and you’re no longer in negative equity. If you cannot wait to sell your home, you can discuss this with your professional mortgage adviser who can approach your mortgage provider to see if they will permit you to port the mortgage to your new home instead of repaying it. Alternatively, you could consider letting out your current home instead of selling it, to allow time for the market to improve.
REDUCING THE RISK OF NEGATIVE EQUITY
If you are in negative equity and you want to sell your home, then your options will depend on how flexible your mortgage lender is about transferring your mortgage to a new property. Some mortgage lenders offer specialist products for people with negative equity to move home. The best way to reduce the risk of negative equity is to put down a significant deposit. This should perhaps be above 10% or 15% of the property’s purchase price. This means you will be borrowing less through a mortgage. If property prices fall, the chance of your property’s valuation falling below the balance on your mortgage is reduced.