Whether you already have a mortgage that you’re paying off or are ready to buy your first home, you need to be aware of negative equity. It can have a huge financial impact on you, making it difficult to move home or remortgage. There are, however, steps you can take to try and get out of negative equity as well as ways to help avoid it in the first place.
What is negative equity?
Normally, as you make regular mortgage payments, you gain equity in your property, which is the amount you own outright. This is the difference between your property’s value and the amount owed for the mortgage. For example, you originally purchased your home for £200,000 and your outstanding mortgage balance is now £180,000. This means that you have £20,000 equity in your home.
Negative equity, however, means that the value of your property is less than your outstanding mortgage balance. This is usually caused when house prices fall. Using the same example above, your property’s value has now dropped to £170,000. This is £10,000 less than the amount owed for the mortgage, meaning that you are £10,000 in negative equity. Being in negative equity can make it very difficult to remortgage or sell your property.
Issues with remortgaging
Remortgaging allows you to change your existing mortgage to a new mortgage deal with a new lender. If you’re in negative equity, though, a new lender is unlikely to agree to offer you a deal as you’d need to borrow more than the value of the property.
As such, once your current fixed or variable rate term ends, you’ll automatically be switched to your lender’s standard variable rate (SVR). As a higher rate than your current one, it will increase your monthly mortgage payments.
Issues with selling
If trying to sell your property, the negative equity means that you would have to sell the property for a price that’s lower than the mortgage still owed. You would need to pay the difference, such as with savings, to clear your mortgage balance before being able to proceed with the sale. If you don’t have funds available to do this, you may be unable to sell and will have to stay put.
What causes negative equity?
Negative equity can be caused by a fall in house prices. This can be due to market conditions, whether for the housing market in general or a change in your local area. Another reason may be that your property is in need of repair or has a structural issue, such as subsidence, that needs to be dealt with, reducing the resale value.
Your property may be leasehold and the lease is nearing the end of its term, lowering the value. You may have bought a new-build property, causing you to go into negative equity shortly afterwards. This is because new builds tend to be more expensive to buy and drop in value once they become occupied.
Having an interest-only mortgage puts you at risk of negative equity because you only repay the interest due each month. As you don’t repay any of the capital, your mortgage balance remains the same throughout your mortgage term. Your risk of going into negative equity is, therefore, higher than if you had a repayment mortgage.
You’re also at a higher risk of negative equity if taking out a 95% or 100% mortgage when buying your property. This means that you have very little equity or none at all in your property, leaving you more vulnerable to fluctuations in house prices.
How to check if you’re in negative equity
To find out whether you’re in negative equity, you first need to check how much you owe for your mortgage. You can do this by either checking your latest mortgage statement or contacting your lender. Then, you need to determine the value of your property. You can either use an online valuation tool to get an estimate of this or ask an estate agent or surveyor to give you a valuation.
What can you do if you’re in negative equity?
If you’re in negative equity, there are various things you can do, as detailed below.
Stay put
If you don’t need to sell, stay in your property and keep making your mortgage payments as normal. This will reduce the balance owed on your mortgage, shrinking the gap that’s causing you to be in negative equity. Over time, the market may improve and property prices may increase again, bringing you out of negative equity.
Make overpayments
If you can afford to pay more than your usual mortgage payments, this will help to reduce the balance of your mortgage. You can usually make overpayments of up to 10% each year without being penalised by an early repayment charge. Check this with your lender first.
Switch to a new deal with your lender
Whilst you may be unable to remortgage with a new lender, you may be able to switch to a new deal with your current lender. This is known as a product transfer. Even though you’re in negative equity, your lender may be able to offer you a deal that has a lower rate than their SVR. That way, you won’t have to worry about paying the higher SVR when your existing deal ends.
Let out your property
If your lender agrees to give you consent to let, you can rent out your property while you either move in with family members or rent somewhere else at a cheaper amount than you’re paying for your mortgage. The rental income can cover your mortgage payments and you can save the difference in your rental payments to put towards your mortgage.
Just bear in mind the extra costs that come with being a landlord, including higher mortgage rates, insurance costs and maintenance and repair costs as well as the risk of having void periods.
How to avoid getting into negative equity
There are some ways to help avoid negative equity, as described below.
Make sure the asking price is fair
When buying a property, check the price carefully to ensure that you’re not paying over the odds for it. Do your research carefully and negotiate to get the right price. If you don’t and end up paying more for the property than it’s worth, you’re at greater risk of going into negative equity.
Pay a bigger deposit
The more deposit you can pay, the less you’ll need to borrow and the more equity you’ll have in your property. This reduces the risk of going into negative equity should the value of your property drop.
Choose a repayment deal instead of interest-only
With a repayment mortgage, you pay off some of the capital each month as well as the interest. This gradually lowers the amount you owe, reducing your risk of negative equity. With an interest-only mortgage, on the other hand, you only pay the interest each month and your mortgage balance remains the same.
If you already have an interest-only mortgage, speak with your lender about changing it to a repayment one. That way, each time you make a payment, it will reduce some of the mortgage balance rather than just paying the interest owed.
Avoid buying a new build
A brand new home can be appealing but newly built properties come with higher prices, called a ‘new-build premium’. Once you’ve moved in, it’s no longer classed as brand new and can decrease in value within your first few years of ownership. If you want to sell it at this point, it may be hard to achieve the same price you paid for it, let alone a higher price.
Make home improvements
Some home improvements can add value to your property, which, in turn, increases your equity. Carefully consider the improvements you want to make first, though, to ensure that you don’t spend a large sum on them and then discover that your property’s value hasn’t changed accordingly.
Speak to our experts about your negative equity concerns
If you’re worried about negative equity and need help making the right financial decision, give our mortgage brokers a call on 01322 907 000. They can offer you impartial advice and compare your options so that you make the best choice for your needs.