Negative equity

Negative equity occurs when the value of an asset, typically a property, falls below the outstanding balance on the loan or mortgage secured against it. In other words, the amount owed on the mortgage is greater than the current market value of the property.

Example:

Imagine you bought a house for £200,000 with a mortgage of £180,000. If the value of the house drops to £150,000, but you still owe £170,000 on the mortgage, you are in negative equity by £20,000 (£170,000 owed – £150,000 value).

Causes of Negative Equity:

1. Falling Property Prices: A decline in the housing market can reduce property values, leading to negative equity for homeowners who bought at higher prices.
2. High Loan-to-Value Ratio (LTV): If a homeowner took out a mortgage with a high LTV ratio, they have less equity in the property. A small decrease in property value can push them into negative equity.
3. Interest-Only Mortgages: Homeowners with interest-only mortgages do not pay off the principal balance, which can lead to negative equity if property values decline.

Implications of Negative Equity:

1. Selling the Property: If you are in negative equity and want to sell the property, the sale proceeds won't cover the outstanding mortgage balance. You would need to find additional funds to repay the lender.
2. Mortgage Difficulties: Refinancing or switching to a new mortgage can be challenging if you're in negative equity because lenders typically require some equity in the property.
3. Limited Mobility: Negative equity can limit your ability to move house, as you may be unable to sell your property without incurring a loss.

Dealing with Negative Equity:

• Overpaying the Mortgage: If possible, making overpayments can help reduce the mortgage balance faster, potentially bringing the mortgage back to positive equity.
• Renegotiating with Lenders: Some lenders may be willing to restructure the mortgage or offer alternative solutions if you are struggling with negative equity.
• Waiting for Market Recovery: If you can afford to stay in the property, waiting for the housing market to recover may eventually restore your equity.

Negative equity is generally considered problematic because it limits financial flexibility and can lead to losses if the property must be sold.