The value of your share in an asset is known as your equity. This can go up and down as the asset changes in value, or as you repay the debt.
Negative equity is a situation which occurs when an asset is worth less than the money owed on a loan secured against it. One common scenario leading to negative equity is a substantial fall in property values.
For example, if you bought a £180,000 house using a £150,000 mortgage, but then house prices dropped so the property is now only worth £140,000, you would be in negative equity.
When dealing with property, this is a particularly sticky situation, and it can have serious implications if you are stuck dealing with it.
In this article we explain negative equity in the context of UK property, looking into what it is, how it happens and its consequences. We then look at techniques and strategies you can employ to deal with it.
How do I calculate if I am in negative equity?
To find out whether you are at risk of negative equity, you need to be able to calculate how much equity you own in your home.
This is a simple calculation, and finding rough data to use for it is fairly easy. You need to know:
- Firstly, roughly, how much your house is worth.
Lots of property websites, such as Zoopla and On the Market offer quick and free online house valuation services, which can get you a ballpark figure in a couple of minutes. Alternatively, lots of estate agents offer a free valuation service too, which can be much more accurate, though expect repeated emails afterwards suggesting you list your house with them for sale. - And, secondly, how much you owe on your mortgage and any other secured loans.
This can either be calculated using an online calculator by putting in your loan amounts, monthly payments, or it can be found out from your mortgage lender, either by contacting their customer services department or on your latest mortgage statement.
By subtracting the amount you owe on your mortgage and any other secured loans from the amount your house is worth you can calculate your equity in the property. This will be a monetary amount in pounds. If this number is negative, you are effectively in negative equity.
Occasionally, people also talk about percentage equity. This can be calculated by dividing your equity in the property by its total value and multiplying it by 100.
What causes negative equity?
If you buy an asset such as a property with the aid of a loan, and the value of the asset goes up, your equity in it increases, as does the proportion of it you own. Unfortunately for some property owners, the opposite is also true.
When an asset you bought using borrowed money goes down in value, the amount of equity you own in it drops an equivalent amount. This can continue until you own none of the asset outright, and even if you sold it, you couldn’t pay the debt off.
Due to price fluctuations in the UK property market, a property crash is typically how people find themselves in negative equity when dealing with homes and mortgages.
There are a few factors in particular which can put you at additional risk of negative equity:
- New homeowners are often particularly vulnerable to negative equity if there is a downturn in the property market. This is because their only equity is their relatively small deposit, which typically at 10% of the property’s initial value only provides a buffer against a 10% fall in property prices.
- Along the same lines, individuals buying with very low equity mortgages of 90%+ are also at risk of negative equity even if property prices only drop slightly.
- Homeowners with interest-only mortgages are reliant entirely on their property increasing in value to increase their equity. If this does not happen, and their property drops in value instead, they may eventually face negative equity.
- If the area your property is in suffers a long-term economic decline and as a result experiences an accompanying drop in house prices, equity can only be built by directly paying off your loan. This puts such property at obvious risk of negative equity unless the relevant loan is paid off faster than it falls in value.
- Finally, if something significant happens to a property to reduce its value to less than the mortgage held against it, you could also be pushed into negative equity. This significant incident can be something like a structural failure in the construction of the property, the discovery of dangerous elements used when it was built, or a recently discovered problem with the deed. Avoiding this situation is one of the main reasons you may wish to employ conveyancing searches and surveys, but these are not foolproof, and unfortunately, sometimes things do fall through the cracks.
What are the consequences of negative equity?
Being in negative equity can bring a whole host of tricky consequences down upon a homeowner.
The specifics of these vary depending on your situation but some apply more generally.
For example, being in negative equity can make it very difficult to sell your house. To do so, you may need to have special permission from your mortgage lender. Unless you have savings that you can use to pay off the difference between your eventual sale price and your mortgage, most lenders will not approve of it.
In addition to making it more difficult to sell your house, negative equity can also put you in a sticky situation when it comes time to refinancing your property. It can be a good idea to re-mortgage your property in order to take advantage of fixed-rate products or cheaper deals which become available as the market changes.
However, borrowers in negative equity generally are not allowed to move to a new mortgage deal. Instead, when a deal expires, they will be transferred to their lender’s standard variable rate. This can be substantially more expensive than a fixed-rate mortgage so you should ensure you can meet these repayments and communicate with your lender if this looks like it could become a problem.
If you fail to meet your mortgage payments and have your house repossessed while you are in negative equity, the bank will sell it and charge you for the difference between its sale price and your mortgage amount. While in theory your lender is legally obligated to seek a good price, the bank will try to sell your house quickly, and it is likely they will settle for less than its full market value. This adds even more to your debt.
While in some cases, lenders may write this kind of debt off, this is far from universal, and many homeowners have been left with substantial debts following a repossession while in negative equity.
What should you do if you find yourself in negative equity?
While being in negative equity can be a scary situation, the situation is far from terminal and there are a whole variety of strategies you can employ to deal with this.
Which is best for you depends on your circumstances. There are many ways to make things work while you recover your equity.
If you want to stay in the property and can afford your mortgage payments:
In this situation, negative equity is often manageable. Your lender cannot just kick you out of your home for owing more than your property is worth, provided you continue to make your agreed repayments.
If you continue to make these, and you are not on an interest-only mortgage, you will slowly build up positive equity in your property. In addition, many mortgages offer you the chance to overpay and bring your loan amount down more quickly, speeding up your return to positive equity.
Finally, it is quite likely that the property market slump that caused the situation is temporary. By simply waiting for prices to go back up you can often return to positive equity with no additional work on your behalf.
If you want to move house:
Moving house can be made substantially harder by being in negative equity, but it is far from impossible.
One option is to rent out the property you want to move out of and use the rent to fund a rental property for yourself. While your lender will need to give consent for this, if you do not give them a reason to suspect it will impact their repayment, they are unlikely to say no.
This has the downside of you paying for both a mortgage, and renting a property, potentially impacting your monthly outgoings but can avoid you having to pay off the difference between a property’s market value and the amount secured against it.
Another option is to sell with your lender’s permission. As you owe more than you will receive from the transaction, this sale will end up costing you money, but it can still work to distance you from a property and its associated monthly costs. In addition, many banks and lenders offer the option of setting up a repayment plan to cover the difference, allowing you to pay it back over several months or years.
Finally, a very small number of companies offer something called a negative equity mortgage. While these have the downsides of high interest rates, and having to pay an early repayment charge, they allow an individual to transfer their negative equity from one property to the next, saving them from repaying that debt.
If you cannot meet your mortgage repayments:
Facing negative equity whilst being unable to meet your mortgage payments can be scary.
If you fail to rectify the situation, you can find yourself out of a home, and owing a substantial debt.
If you need to stop a repossession going ahead, you should take legal and financial advice and talk to your mortgage lender to try and find a solution to your situation.
How do you avoid this?
While who is afflicted by negative equity is often heavily determined by bad luck, there are a few key strategies you can employ to reduce your chances of falling into it.
The key initial piece of advice is to simply not get a mortgage where you have a tiny amount of equity. If you wait until you can afford a deposit of 20% or more, there is a far smaller chance of a house price crash driving your equity to zero.
Additionally, interest-only mortgages, while being a good way to reduce your monthly bill, can also boost your vulnerability to negative equity. If you are not paying back your loan, the only thing changing the amount of equity you have in your property is fluctuations in a property’s value.
In Summary
When you have negative equity in a property or asset it means you owe more on a debt secured against that asset than you could get for selling it.
With houses and flats, in the main, this typically happens when a housing market crash causes property prices to drop.
While being in negative equity on your home mortgage is not going to lead to you being thrown out of your home, it can lead to higher mortgage rates, be a serious impediment if you want to sell, and add to your woes if you suffer repossession.
Solving negative equity is simple in theory, but in practice is easier said than done. Nonetheless, by paying off your mortgage at a steady rate, you can eventually build yourself back up into positive equity.
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