Negative equity is when the amount owed on a secured debt is more than the value of the asset on which it is secured. The term is generally associated with the property market although it can be used in other contexts. For homeowners, being in negative equity is generally an undesirable situation. It is, however, not necessarily a catastrophic one.
How borrowers get into negative equity
In the UK, at present, the only way for borrowers to get into negative equity is for house prices to fall after a purchase has been completed. For completeness, there used to be other ways.
For example, some lenders allowed mortgages for over 100% of the purchase price. There may still be some people impacted by these products but they are currently no longer offered.
There can be many reasons why a property would decrease in value. In many cases, this is due to economic conditions (macro or local). Once these are resolved, then property prices will generally recover.
In some cases, this may be due to issues with the property itself or development in the local area. Again, if these can be resolved, property prices will generally recover quickly. Even if they can’t, over the long term, inflation will generally do its work and resolve the situation.
Challenges and implications of negative equity
There are two main reasons why negative equity could pose a challenge for homeowners. The first is that it can make it more difficult to sell the property. The second is that it can make it more difficult to remortgage a property.
In both cases, the issue is that homeowners would need to find extra money to cover the gap between the sales price/current fair value and what they owe on their mortgage. Remortgaging is likely to be even more of a challenge than selling.
This is because selling just requires borrowers to pay back what they owe. Remortgaging generally requires borrowers to put down a nominal deposit. In other words, usually, borrowers can only remortgage for a percentage of the value of their home. This may be a relatively high percentage (e.g. 80%) but it still requires them to find more money.
When negative equity is not a problem
If you’re not planning to sell or remortgage your home and you can afford your mortgage repayments, then negative equity does not have to be a problem. Essentially, you can ride it out and wait for a combination of your repayments and inflation to bring you back into positive equity.
Strategies to avoid or minimise negative equity
In simple terms, the more equity you have in your property, the less chance there is of you finding yourself in negative equity. When you are first buying your home you should, therefore, aim to put down as large a deposit as you possibly can. In fact, many lenders will insist that buyers put down substantial deposits.
For completeness, this is not true of all lenders. At present, it is still possible to get a mortgage for the full value of a property (a 100% mortgage). These mortgages are, however, very unusual due to the level of risk involved.
In addition to putting down as large a deposit as you can, you may be able to make overpayments on your mortgage to build equity faster. If you can’t then you could save the money and keep it as a cushion against negative equity.
Dealing with negative equity
There are a couple of ways to deal with negative equity. As previously mentioned, if you are happy to stay where you are and can afford your mortgage, you can just ignore it. Over time, the issue will right itself.
It can be prudent to take out Income Protection Cover and/or Payment Protection Insurance to ensure that you continue to pay your mortgage even if you experience illness or unemployment.
If you do need or want to move, there are currently a small number of providers who offer negative equity mortgages. Essentially, these are mortgages that allow you to port any existing negative equity to a new mortgage. You can increase your chances of being approved for such a mortgage by keeping your credit record in good order.
