Negative equity is one of those opaque terms that the housing industry likes to use but doesn’t mean much to normal people.
Basically, when most of us buy a property we do so with a combination of a deposit – say 10% – and a mortgage.
The equity that we own in a property is the difference between the outstanding mortgage and the overall value of the property. So if I buy a £200,000 with a £20,000 deposit, I have £20,000 equity in the property.
The idea is that over time, as I repay the mortgage and (hopefully) the property’s value increases, the amount of equity I own will increase.
However, if house prices fall, then things can easily go the other way, leaving you in negative equity.
This is where the outstanding mortgage is larger than the overall value of the property – in other words, I owe more than it’s worth.
You won’t lose your home!
Right, let’s get the first big misconception out of the way.
Being in negative equity does not mean you will lose your home – so long as you keep up with your monthly payments.
If you’re on a repayment mortgage you will eventually clear that loan in full and own the property outright just by doing this – and will be out of negative equity faster as your monthly payments reduce the outstanding debt.
If you’re on an interest-only mortgage, things are trickier – as the only way to get out of negative equity is for house prices to rise again. Generally this will happen over time, but it’s not guaranteed, and as long as you meet payments your debt won’t be called in.
But while you won’t lose your home because of negative equity, it can make your life a bit tougher and more expensive.
Remortgaging becomes tougher
The first area where negative equity will cause issues is when you come to remortgage.
Generally when you sign up for a mortgage, for the first couple of years you’ll have a nice promotional rate.
When that period comes to an end, you’ll move onto your lender’s standard variable rate (SVR) – this is a rate they can increase at any time, and tends to be far more expensive than the rate you’re leaving.
As a result, before you land on your lender’s SVR, it’s a smart move to remortgage to a new deal.
Unfortunately, you will struggle to do that when you’re in negative equity – lenders won’t offer you a deal when you are looking to borrow more than the property is worth, meaning you are probably stuck on your existing deal until you manage to get out of negative equity.
And the inability to remortgage will cost you.
A new study from Legal & General Mortgage Club suggested that borrowers on an SVR who moved to a new two-year fixed rate could save more than £4,500 over that period.
The longer you are in negative equity and so unable to remortgage, the more those missed savings will add up.
Moving house is difficult too
Negative equity will throw a spanner in the works if you want to move house too, perhaps because of a job change or to accommodate a growing family.
Normally if you move house, you use the money you get for your current property to repay the mortgage and act as a deposit for the next property.
But that’s not possible if you’re in negative equity – you’ll still owe some money on the original mortgage, and won’t have any funds from the sale to use as a deposit.
If you want to move home, you’ll therefore need to find the cash elsewhere to act as a deposit and to finish paying off the original mortgage.
Some lenders will at least consider your case if you are in negative equity and need to move, taking some of the outstanding mortgage with you.
With Nationwide for example, you need to demonstrate that you need to move, are in permanent employment and can afford the new borrowing.
How can I get out of negative equity?
Put simply, if you want to get out of negative equity you need to get to the stage where your property is worth more than the outstanding mortgage.
As such, you have a couple of options.
The first is to reduce the size of the mortgage. This will happen over time anyway, but you can give it a helping hand by overpaying.
Most mortgages allow you to do so by up to 10% a year, or £500 a month, without incurring any additional charges.
The other route is to look at ways to increase the value of your home.
This is obviously a risky business – there is no guarantee that spending money on something like an extension or a new kitchen will bump up the value of your home enough to get you out of negative equity. But it may make a difference.