Negative equity is a term that every homeowner hopes never applies to them. But what does it mean, how does it happen and, most importantly, how can you get out of it?
What is negative equity?
Negative equity is when the total borrowing that’s secured against your home is greater than the price you could sell it for. For example, if your outstanding mortgage is £200,000 and your home is only worth £180,000, you’d have £20,000 worth of negative equity.
Secured loans and second mortgages can also contribute to negative equity. For example, an £8,000 loan on top of your £200,000 mortgage would put you in £28,000 worth of negative equity if your home was worth £180,000.
It is not possible to be in negative equity if you rent your home or you own it outright without a mortgage.
How does negative equity relate to loan-to-value (LTV)?
Your loan-to-value (LTV) is what you owe on your home as a percentage of what it’s worth. For example, if you owe £225,000 on your mortgage and your home is worth £300,000, you’d have a loan-to-value of 75 per cent. If you only owe £150,000 on your mortgage and your home is worth £300,000, you’d have a loan-to-value of 50 per cent. The lower your loan-to-value the better – but if you are in negative equity it will be more than 100 per cent.
Causes of negative equity
There are a number of reasons you could find yourself in negative equity - and frustratingly, these can apply even if you’ve been making your agreed mortgage payments every month, on time.
Falling house prices: Falling house prices are the most common cause of negative equity. The two most recent house prices crashes that affected large swathes of the country were in the early 1990s and in 2008 when the credit crisis struck. The plummeting value of property during these times left those with larger debts living in homes that were suddenly worth less than their mortgage balances.
High loan-to-value borrowing: The bigger the loan you took to buy your property, the quicker you’ll be sucked into negative equity in the event that house prices fall. That’s why, since the credit crisis, banks and building societies have been much more cautious about their lending.
Before it all started going wrong in 2008, you could borrow 100 per cent or even more of a property’s value. Now the absolute maximum you can borrow is 95 per cent and even then you’ll be subject to extra-stringent credit and affordability checks and may also be offered a smaller loan as a multiple of your salary. You’ll also have to pay a top rate of mortgage interest compared to even 85 per cent or 90 per cent loan-to-value loans.
Having an interest-only mortgage: As it says on the tin, an interest-only mortgage is when you only pay the interest on your loan every month and not the capital. In other words, if you started with a £180,000 mortgage, 10, 20, or any number of years later, your debt would still be sitting at £180,000. You might be keeping a roof over your head, but your actual borrowing is not reducing. This is why homeowners with interest-only mortgages - especially if they also have a high loan-to-value - are at a greater risk of entering into negative equity if the value of their property falls.
Taking out additional secured borrowing: As already mentioned, it’s not just the size of your primary mortgage that can push you into negative equity. If you have a ‘top-up’ second mortgage or a secured ‘homeowner loan’ (which paid for, say home improvements or a new car), you’ll also be at a greater risk of negative equity.
Missing mortgage repayments: Failing to meet your mortgage repayments is only likely to affect your risk of negative equity if it’s in combination with one or more of the above scenarios. That’s because your home will be repossessed by the lender quicker than your lack of payments alone could take you into negative equity.
If you are struggling to pay your mortgage, the first thing to do is to contact your lender and explain the situation. You may be able to come to a temporary arrangement such as a payment holiday, extending the term of the mortgage or even switching to an interest-only deal. And there’s nothing to lose by calling a free and independent debt charity, such as Step Change, to talk through your options.
How does negative equity restrict you?
Whichever of these reasons - or combination of reasons - you came to find yourself in a situation of negative equity it can soon have a big impact not just on your finances but your entire life. Here are the main reasons why:
You won’t be free to remortgage: If you are coming to the end of your mortgage deal - a three-year fix for example - and want to switch lenders it’s very unlikely your application will be accepted if you’re in negative equity. Your existing lender is likely to respond better if you make contact and try to negotiate a new deal. But it’s wise to have a plan B as the truth is a position of negative equity is not a great starting point.
With negative equity in tow, chances are your lender will put you onto its standard variable rate (SVR) at the end of your current mortgage deal. But, as SVRs are generally more expensive, this means your monthly mortgage payments could go up. SVRs are also variable so - for better or worse - your repayments could change at any time too.
It’s important to note however, that just being in negative equity does not mean your lender can repossess your home. So long as you are making the agreed mortgage payments in full and on time, it must honour the contract it made with you.
You may not be able to sell your home: The nature of negative equity means you have a shortfall between your mortgage debt and what you can sell your home for - and this debt is your responsibility. So unless you have means of paying it off, such as adequate savings or a loan from a family member, you may not be able to sell. The next section of this guide will explain how best to tackle the problem.
How to get out of negative equity
Once you understand what negative equity is and how it can happen, the million dollar question is how do you get out of it? At least here there are some very tangible measures you can take. If you are able to stay in your current home, consider the following:
Stay put and weather the storm: We’ve seen a few dips in recent decades but generally, and in the long term, the value of property in Britain trends upwards. So providing you keep making your monthly mortgage payments, it’s likely that over time your negative equity will erode by itself. If you can, batten down the hatches and wait for it to pass.
Overpay on your mortgage: There are things you can do to speed up this process though, such as overpay on your mortgage. If you are on your lender’s SVR, the good news is you won’t be subject to tie-ins or early repayment charges (ERCs), so you are free to pay a chunk off your mortgage any time you like. If you don’t have the enough savings in the bank to do this, you should be able increase your monthly payments instead. Either option will result in paying your mortgage down quicker.
Even if you are midway through a specific mortgage deal, a fix or tracker for example, you will still be permitted to make some overpayments without having to fork out charges. Lenders usually allow overpayments of up to 10 per cent of their running mortgage balance in each year. Other lenders impose a fixed sum or employ their own more complex overpayment calculations. Call your lender to find out. But the bottom line is, if you can afford it, you can almost always pay your mortgage down quicker if you want to.
Take care of your castle: Making sure your home is as good as it can be - that means everything from treating rotten wood to servicing fixtures and fittings - will keep the ‘micro’ value of your home intact, even if its ‘macro’ value has suffered from a falling property market. If you are in the position to make more major improvements to your home, for example, you work in the building trade, you could even add value.
If you really need to move home and you are in negative equity, here are your best options to explore:
Borrow the shortfall: If a family member or friend could lend you the shortfall between your mortgage and your property value, it would be nothing short of a golden ticket. With the gap plugged, you’d be back on level ground and free to sell up and pay your lender back 100 per cent of what you borrowed. For the purposes of keeping relationships intact, it’s a good idea to get a repayment plan in place.
Become a negative equity landlord: Think about renting out your home. If the market in your area is strong and the kind of home you have is easy to rent - a two-bed, two-bathroom flat near the station for example - the rental income might cover the mortgage or even provide a small surplus.
There are some sticking points, though. First, as you are changing the terms of your mortgage, you will need to tell your lender of your plans. It may then require that you convert your mortgage from residential to buy-to-let. As buy-to-let mortgages come with bigger deposit requirements, this transition may not be workable - but it’s one worth exploring.
If you can prove you need to rent your home because of work commitments or financial hardship, your lender might agree to what’s known as ‘consent-to-lease’. It could still impose a one-off fee to make the amendment and could even raise your interest rate, so do your sums carefully. You’ll also have to tell your insurer if you rent out your property as the terms on your existing policy will also have changed.
Take out a specialist mortgage: A spattering of mortgage lenders will take you and your negative equity on by lending more than 100 per cent loan to value against your new home. But be prepared for these deals to be expensive and restrictive. If you are considering this route, your best bet is to contact an independent mortgage broker for advice.
Come to an agreement with your mortgage lender: Depending on your circumstances, your lender may be able to help. It may be that transferring the negative equity balance to an unsecured loan or even writing off the debt is cheaper for them if repossessing your home is the only alternative. Both of these courses of action however, are pretty drastic. They would leave a black mark on your credit score, making borrowing in the future a lot more difficult.