CashNews.co
Basically, negative equity is when your property is worth less than the amount left to pay on your mortgage.
For example: you buy a house worth £200,000 with a £20,000 deposit and a mortgage of £180,000.
After two years in the property, you pay off £10,000 of your mortgage – but another valuation of the house finds that it is now worth only £160,000.
You still owe £170,000 on the mortgage, meaning you have negative equity of £10,000.
Falling house prices, large loan-to-value ratios and being on an interest-only agreement increase the risk of negative equity.
(If you’re wondering exactly what equity is, we’ve got a handy explainer here from another in our Basically… series):
How does negative equity occur?
The housing market can be unpredictable, and a price crash could put even the most financially savvy homeowners in trouble.
A major negative equity crisis hasn’t happened since the early 1990s, when it’s thought somewhere between one and two million households were left in negative equity due to falling house prices.
But having a low or even no-deposit mortgage puts you more at risk of falling into negative equity as you haven’t built up a significant amount of equity in your home.
Similarly, if you’re on an interest-only mortgage, you’re more at risk because you are only ever paying the interest on the amount you owe, rather than the mortgage sum.
Because you’re not paying off the mortgage, you are again not building up equity, meaning a price fall could put you at risk.
What are the consequences?
If you still have a bit of time left on your mortgage term and aren’t planning to move, you don’t necessarily need to worry about negative equity immediately – you can try and increase your equity or see if house prices rise again.
If you wanted to sell your property, however, it’s unlikely that you’d make enough to repay your outstanding loan to the bank, meaning you’d still owe them money.
Unless you have savings, you’d have to find a way to cover the shortfall.
Negative equity can also make it tricky when it comes to remortgaging, as lenders may choose not to take you on as a new customer. If they do, they may only lend against the current value of your home, leaving you with a shortfall and reducing your property options.
How can it be avoided?
There are several ways you can put yourself in a good position to avoid negative equity when going through the house-buying process.
Firstly, do some research. Make sure the asking price is fair for the location and don’t be lured into paying over the odds.
Buying at the right time can also help – understanding when prices are high or low can improve your chances of getting a good deal and avoiding a major house price downturn.
If you can afford to, pay a bigger deposit. The larger the amount you put down initially, the more equity you have in your property. With more invested, the less chance you’ll ever need to worry about negative equity.
And lastly, avoid interest-only deals unless you really need one, to ensure you’re building up equity through paying off the mortgage over time.
Read other entries in our Basically series…