Negative equity? What it is and what to do
Negative equity is when the value of your home is less than the size of your mortgage.
This can happen if house prices drop, which is why so many people fell into negative equity as a result of the global financial crisis. (1)
Between September 2007 and February 2009 average UK prices plunged by about 20%, from around £190,000 to £155,000. (2)
As a result, it’s estimated that between 7-11% of UK homeowners with a residential mortgage were in negative equity by spring of 2009. (1)
People taking out a mortgage with a smaller deposit - say 5% - are more at risk of falling into negative equity. This is because the value of their home only needs to fall by 5% for their loan to be worth more than their house.
Is negative equity still a problem?
Yes, in some areas.
In Northern Ireland average house prices are still well below pre-credit crash levels. The typical price was around £225,000 in September 2007 and was just shy of £137,000 in June 2019.
London is also seeing house prices falling. Prices dropped by 2.7% over the year to June 2019. In fact, average house prices in London have now been falling over the year each month since March 2018. (2)
People who’ve fallen into negative equity are often called ‘mortgage prisoners’ in the press. This is because historically they wouldn’t have been able to switch to a cheaper mortgage deal or change lender. Lenders test whether you can continue to afford your mortgage if interest rates go up by 3%.
However, things are improving when it comes to how some lenders are treating people in negative equity.
‘Prisoners’ with active lenders - those still accepting new mortgage business - who roll onto expensive Standard Variable Rates (SVRs) are now often able to transfer to a more affordable product with the same lender, providing they don’t want to borrow more.
Prisoners with inactive lenders
Not everyone’s been helped to switch to a cheaper deal, however. Prisoners with lenders that are no longer active - like a company or fund that doesn’t offer remortgages - are more likely to be stuck on SVRs.
Let’s explain that a bit more.
When the loans - also known as the mortgage book - of an active lender are sold they sometimes end up being managed by third parties that don't accept new business, or aren't regulated to receive new business. This is why there were fears around who Tesco Bank would sell their mortgage book to recently.
The regulator, the Financial Conduct Authority, is looking to help these people by giving active lenders permission to accept these customers providing they aren’t borrowing more. (3)
What to do if your home is in negative equity
If your home is in negative equity, the best thing to do is to resolve the situation as soon as possible.
Make sure you’re on one of your lender’s more competitive mortgages, so you’re at least paying off some of that equity cost-effectively, rather than paying a high rate of interest on a SVR.
If you’re not on one your lender’s better deals, get in touch with them to see if you can switch to one. Bear in mind that you’ll have to stick with your current lender if you’re in negative equity, as another lender won't want to take on your situation.
It could be more cost-effective to spend money on home improvements to increase the value of your home. This would be more the case if parts of your home were down at heel, such as old carpets that needed replacing.
Can you sell if you’re in negative equity?
Yes, but you should get permission from your lender before selling your home for less than the value of your loan.
Once you sell your home the lender will ask for the shortfall. You’ll need to arrange to repay it or they could take you to court. You might be able to pay off the debt using a payment plan.
If you want to sell and buy elsewhere you may be able to transfer - or port - your existing mortgage, though this is something you’d need to discuss with your lender.
Keep talking to your lender
“Falling into negative equity can be a very stressful experience,” said Haris Sehic, a Mortgage Adviser at Trussle.
“If you’re worried about negative equity, consider saving for a bigger deposit so you won’t be as affected should house prices fall.
“If you’re a mortgage prisoner, keep the lines of communication open with your mortgage lender so you can resolve the situation as quickly as possible.
“Don't be tempted to simply stop paying. Mortgage arrears will put a black mark on your credit record and may prevent you from buying a house in the future.”
(1) Bank of England