Falling house prices have put the prospect of negative equity back on the cards – an issue few people have had to worry about for years.
Negative equity is when the value of your property reduces, meaning that it's worth less than what you owe on your mortgage.
Experts predict sellers could face an 'uncomfortable' year as an increasing number of people face the risk of their home's value decreasing.
Those with low deposits are most likely to be affected – but with varying house price predictions forecast for 2023, could negative equity become a more widespread issue?
Here, Which? explains what negative equity is, why it's potentially returning to the frame, and what it means for your finances.
What is negative equity?
If you owe your mortgage lender more than what your home is worth, you're in negative equity.
'Equity' refers to the current value of a property, minus the outstanding loan amount (your mortgage). If this amount comes out at a figure below zero, it means your property is in negative equity.
Say you buy a £180,000 home with a £20,000 deposit, you'd take out a mortgage for the remaining £160,000.
If you pay off £5,000 in the first year you'll have £155,000 remaining on your mortgage. But if the value of your house was to drop by 20% in the space of a year, it would then be worth £144,000.
This means you'd be in negative equity by £11,000.
- Find out more: loan to value (LTV) calculator
Will falling house prices cause negative equity?
As shown in the example above, should the value of your home decrease, the equity will also be affected.
The housing market has been showing signs of slowing for some time, and property prices are now falling from their peak levels, with more significant drops expected this year.
Halifax data shows that in November 2022, prices slumped by 2.4% – the largest monthly drop since the beginning of the financial crash in 2008.
While experts are in agreement of the downward trend continuing, forecasts are mixed. Analysts at Capital Economics predict house prices will fall by 12% come mid-2024, yet Rightmove only foresees a 2% drop this year.
The scale of the house price descent will determine how great a risk negative equity will be.
'Millions won't suddenly plunge into negative equity'
The general consensus is there would need to be a significant price crash for lots of homeowners to have mortgages costing more than their property's value.
Jonathan Rolande, from the National Association of Property Buyers (NAPB), does not believe there is a serious risk of mass negative equity this year.
'Prices would have to drop at least 15% from their peak to see a lot of people in negative equity. However, many will begin to see the price they paid is higher than the current value – an uncomfortable feeling, for sure, but only relevant if you're actually trying to sell up.
'So far at least, the property market is proving resilient and price reductions have been quite small – a few percent or so. This keeps many out of danger.'
Zoopla shares a similar viewpoint, with the property portal stressing that a 'nationwide 10% reduction in house prices would result in very few cases of negative equity'.
- Find out more: how much is your house worth?
Who is most at risk?
Despite the not-so-glum outlook, there are still some homeowners that could slip into negative equity quite easily – namely recent homebuyers with low-deposit mortgages or interest-only deals.
When you take out a mortgage to buy your first home, your equity is your deposit. So, if a recent homebuyer put down a low deposit of 5%, their equity would be 5% of the property's value.
But with house prices falling month-on-month, new homeowners could quickly be nearing negative equity. For example, the latest figures from Rightmove show property prices in Scotland last month fell by 5.2%.
Anyone who paid over the odds for a property before prices began to fall will also be in a more unfavourable position, as it may be more likely to fall in value.
- Find out more: how much deposit do you need for a mortgage?
When does negative equity become an issue?
Through no fault of your own, negative equity can put you in a tricky financial situation. But it's only really relevant for those who are trying to sell their home, or get a new mortgage:
You'll lose out when selling up
If you want to up sticks when your property is in negative equity, you'd make a loss. You won't make enough from a sale to repay your loan, and would therefore continue to owe money to your lender.
So, if you can, it's best to bide your time – hold off for a year, see how the market pans out and continue to build up your equity via your mortgage payments.
However, if you do need to move, talk to your lender – in some cases it may allow you to repay the debt over time using a payment plan. Another option is letting out your property and renting elsewhere. However, you'll be responsible for meeting mortgage repayments when the property is vacant, as well as paying rent at your new place.
It can be difficult to remortgage
As well as leaving you out of pocket if you want to sell, negative equity can make it difficult to remortgage as your lender would be unlikely to approve a new deal.
Your property would not be sufficient security to cover the money you've borrowed, which means you'll likely be stuck with your current lender and put on a more expensive standard variable rate when your deal expires.
What are your options?
The options available to you will depend on your circumstances, and what your plans are for your property.
Staying put is good option
If you're in negative equity but are not planning on moving or remortgaging, it's unlikely to have any effect on you.
Your home's dip in value will probably rectify itself over time, and the likelihood is that your property value will soon surpass your outstanding loan.
Consider over-payments
Making over-payments – if your mortgage deal allows it – would reduce your loan more quickly if you want to boost equity.
Most mortgages will allow you to overpay around 10% per year without incurring any extra fees. By paying off the loan more quickly, you'll also save on interest payments.
- Find out more: use our mortgage overpayment calculator
Contact your lender if you're struggling with repayments
If you're having problems keeping up with your mortgage repayments – particularly if they've risen due to being moved to your lender's SVR deal – contact your lender as soon as possible. It may be able to offer options to make your payments more manageable.
- Find out more: what to do if you're struggling to pay your mortgage
How buyers can avoid negative equity
If you're looking to buy a property and you're concerned about negative equity, it is crucial to do your research to make sure you're paying fair market value – especially as we could see house prices drop further this year.
Put down as large a deposit as you're able to; those who put down small deposits are most at-risk when house prices drop.
The government has this year extended its Mortgage Guarantee Scheme, which enables people to buy a property valued up to £600,000 with only a 5% deposit. This is good news for those struggling to get on the housing ladder – but beware of the potential pitfall of falling into negative equity.
source https://www.which.co.uk/news/article/are-you-at-risk-of-negative-equity-this-year-a0nrI4m02rlA