As an example, according to recent data house prices from around the M25 have increased by a whopping 550% since the road was constructed 30 years ago – an average price of £59,183 in 1986 has rocketed to £385,085 in 2016. The average price of a home in June 2016 was £214,000 – £17,000 more than a year before. Anyone who had borrowed enough to pay for their home will conceivably be much better off when they come to sell it, although of course, other homes will also have risen in price.
But for some people the situation is less rosy. For a number of reasons, home prices can devalue once a mortgage has been taken out – and we then have the situation of negative equity.
Simply put, negative equity refers to a situation where you have borrowed an amount of money for a home, and its price then starts to fall – meaning that you owe more than the value of the home.
It’s actually quite common in every sphere of life other than homes. For example, you might take out a financial plan to buy a new car at £20,000 – the moment you drive it from the forecourt it falls in value by several thousand pounds, but you must still pay back the £20,000 plus the interest agreed in the financial arrangement.
For property, in a worst case scenario, your home could fall by several thousand pounds or tens of thousands of pounds. This will then cause particular problems if you come to sell or re-mortgage the home, because lenders simply won’t let people switch over to a new and potentially cheaper deal. That’s because negative equity will push your LTV (Loan to Value) upwards and over 100 per cent.
In effect, you’ll be borrowing more than the value of your home and could be falling into deep debt. Therefore, if you did sell the home at a later date you would also have to pay off the difference – if the mortgage lender will allow the sale.
As discussed earlier, average house prices are generally rising, meaning that a small percentage of homes fall into the negative equity category – as few as half a million in the UK, although this is much higher in Northern Ireland. In London, only 1% are affected.
Falling house prices is the biggest reason for negative equity, and there are a huge number of reasons for this. These include changes in economic stability (such as credit crunch) which can lead to a shortage of lenders; conditions stopping people from borrowing as first time buyers; an excess of new homes; and an increase in interest rates that hits customer spending.
These are large-scale reasons, but there may be many more at a local, micro-level. Anything from a business pulling out of investing in a particular area, to rising crime rates, to a new road being built nearby, to an oversupply of homes, could all lead to a fall in property values. Finally, there are issues that may relate specifically to the property itself, such as the discovery of structural deficiencies; flood damage; letting the home fall into disrepair; or even a boundary dispute that is settled in another party’s favour.
Several steps can be taken to try to solve the problem – the first one is to try to avoid it in the first place (see below).
Step number two is simple – don’t panic! Speaking to a housing expert may alleviate some concerns. They will know if the decline in value is likely to be a long-term problem, or merely one that will reverse in a few months’ or years’ time. If you’re not planning to move to another home, then your best course may simply be to stay put and do nothing.
The next option is to try to make up the difference, perhaps by overpaying on your mortgage. Some lenders will allow you to make overpayments of up to 10% a month or less, which should be considered. The alternative is to stick to your current payments, and when you sell the home pay off the difference. Some mortgage companies will allow you to sell a home for less than it is worth, but it’s at their discretion – your finances will need to be assessed.
Negative equity happens through no-one’s fault, so it should not be something to be ashamed of. Instead, professional help should be sought if necessary. This could include the Citizens Advice Bureau, Shelter, or any other relevant charities (This might also include health charities if it is causing you to be ill through stress). Advice from these charities will be free, but even if you have to initially pay for financial advice it could still save you substantial amounts of money if the negative equity is reduced.
A final option is to pay off the shortfall, perhaps through borrowing from a friend or family member, and/or saving up. When your current mortgage term finishes, using money in the bank to pay off the shortfall will essentially clear everything. The lender will have been paid back what you borrowed, meaning you can pursue favourable re-mortgage conditions.
Firstly, the bad news: there is no definitive step one can take to ensure that your home will not devalue. Indeed, you may not even know that your home is in negative equity if you are not aware of the housing market or looking to move. The first point at which you’ll realise could be at the point of re-mortgaging, or if your house is being surveyed.
Some areas are particularly vulnerable. According to the Homeowners Alliance, 17 of the 20 worst affected areas are in the north – worth bearing in mind if you’re thinking of moving there. On other occasions, the problem is a national or even global one – there were two price crashes in the early 1990s and amidst the credit crunch of 2008. Who can tell what the long-term effects of Brexit will be?
One way of at least preventing the worst of the damage is to take out a big deposit; remember, negative equity only occurs on money that you owe, so the less you owe, the smaller the effect. It might be difficult for first-time buyers but ideally aiming for an LTV of 75% or less would be beneficial.
As previously discussed, the lender may be willing to arrange a way of transferring the negative equity to a separate loan, especially if you risk losing your home. These arrangements should be viewed with some caution as they will impact your credit score.
Another potential solution is renting out the property to cover the costs, although this would need to be arranged with the lender and may not always be possible.
A final option is to stop or even try to reverse the falling house price, by making improvements or fixes. Options include redecorating, adding a conservatory, putting in a new kitchen/bathrooms, and changing fittings. There’s possibly a balance between using this option or alternatively using the money to pay off the shortfall, but you might know people who can do these jobs cheaply – who knows, it might even add value to the home.