What’s negative equity and when is it a concern?

As the UK property market faces uncertainty and stalling prices, you may be worried about the risk of negative equity. But what is it and should you be concerned about it?

When you purchase a home, it’s common to take out a mortgage to cover the cost. It’s probably the largest loan you’ll ever take out. The portion of the home you own outright is known as equity. If you buy a home with a 20% deposit, using a mortgage to cover the rest, your equity at the time of purchase is 20%. Your equity is affected by the repayments you make and the value of your home.

Historically, house prices in the UK have increased and homeowners have benefitted from significant gains on their property investments. But this isn’t guaranteed. Should the value of your home fall, so does your equity in it. If the value of your home is less than the amount on your mortgage, you fall into negative equity.

After years of rising house prices, they’re now stalling, and some regions have even seen a fall. It’s a trend that’s been linked to the uncertainty of Brexit. With the full impact of Brexit still unknown, it’s possible that house prices could remain stagnant or decrease over the coming months or years. For some, it may mean that negative equity is a concern.

Who is at risk of negative equity?

If you’re worried about how potentially falling property prices could affect you, the first step you should take is to calculate the current level of equity you have in your property.

Those with a lower stake in their property are more likely to be affected by negative equity. The value of a property can fluctuate, but it’s rare for prices to fall rapidly. As a result, if you own a significant portion of your home, the impact of falling property prices will be less severe.

It’s often first-time buyers, particularly those that have taken advantage of 100% or 95% mortgages that find themselves trapped in negative equity. However, homeowners that have taken out an interest-only mortgage and are relying on capital growth and those that have remortgaged to access wealth tied up in property can also be affected.

Negative equity essentially means you owe more on your mortgage than the value of your home. It can seem like a major concern, but the important thing to remember is that, in many cases, it doesn’t have an immediate impact. Historically, house prices have increased over the long term, even after experiencing dips. As a result, negative equity is only an urgent issue if you plan to sell or need to take out a new mortgage product.

Selling your home while in negative equity will mean you lose some of the money you’ve invested in the property. While if you need to find a new deal, it can affect your ability to be approved for a new product. This can mean you’re stuck on a Standard Variable Rate (SVR) mortgage, which typically has higher interest rates than alternatives.

Calculating your equity

Calculating the current level of equity you have is relatively simple. However, you do need accurate, up-to-date information on the amount outstanding on your mortgage and the current value of your property.

Your equity is simply the current property value minus the outstanding loan, if the figure is below zero, your home is currently in negative equity.

What can you do if you’re in negative equity?

If you have negative equity and it’s impacting your decisions, such as your ability to move home or swap to a different mortgage deal, you have a few options open to you:

  • Increase your equity: The simplest solution is to increase the equity you hold, though it’s not feasible for everyone to do this. The most straightforward way to do this is by reducing your loan amount, either through overpaying your mortgage or paying off a lump sum if you have the means to do so. Another solution is to increase the value of your home. Of course, while this option is the simplest, it does require you to have additional funds and you may still end up losing out.
  • Wait it out: As mentioned above, the housing market has recovered from dips in the past. Where possible, waiting out the low in the market can mean that having negative equity doesn’t have an impact on you. Even after the 2008 financial crisis, when house prices fell quickly, they did recover. Official figures show the average UK house price in September 2007 was £190,032 and dipped to £154,452 in March 2009. Despite the relatively steep fall, within five years the average house price had surpassed the 2007 peak, standing at £225,047 by February 2018.
  • Accept the loss: If you need to move home while in negative equity, you can accept the loss. If you sell your home for less than the remaining mortgage, you will need to make up the shortfall. It’s not an attractive route and often it’s preferable to wait the market out. However, if you have little other option, it may be the right decision for you.
  • Seek specialist lenders: It’s true that your options of securing a mortgage with negative equity are limited, but there are still specialist lenders. Often, you’ll have higher interest payments than alternatives, but they could prove lower than the SVR and if moving is important to you, it gives you more flexibility. If you’re worried about your ability to secure a mortgage, please contact us, we can help connect you with those providers more likely to approve your application.