Negative equity is when the total borrowing secured against your home is greater than its value.
For example, if your outstanding mortgage is £100,000 and your home is only worth £80,000, you’d be in £20,000 negative equity. Secured loans and second mortgages also contribute to negative equity.
You can’t be in negative equity if you own your home outright without a mortgage or other loan secured on it.
Negative equity and loan-to-values
Your loan-to-value (LTV) is what you owe on your home as a percentage of what it’s worth. For example, if you owe £80,000 on your mortgage and your home is worth £100,000, you’d have a loan-to-value of 80 per cent. If you only owed £50,000, your LTV would be 50%.
If your loan-to-value is more than 100%, you’re in negative equity.
Negative equity is not as big an issue as it used to be. This is because mortgage lenders have become a lot more risk adverse over the past decade and are wary at lending at high LTVs.
This wasn’t the case before the credit crunch in 2008. Back then some lenders would lend up to 125% of a property’s value. They were happy to do this as they were sure house prices would continue to rise. However, it put some homeowners in negative equity straight away.
In the current market it’s virtually impossible to borrow more than 95% of your home’s value. This more responsible approach to lending means fewer homeowners are at risk of negative equity.
How do you get into negative equity?
The main cause of negative equity is falling house prices coupled with borrowing at high LTVs. For example, if you borrowed £95,000 to buy a £100,000 house (i.e. with a £5,000 deposit), your loan-to-value would be 95%.
But if the value of your house fell to £90,000, and you still owed £95,000, your loan-to-value would be 105.55%. This means you’d be in negative equity.
The lower your LTV the better, as it cushions you against falling house prices. Mortgage lenders offer their best rates to borrowers with lower LTVs – so the more deposit you can save the better.
Other causes of negative equity
There are a couple of other causes of negative equity. These include:
- Interest-only mortgages
- Additional secured borrowing
We explain more below.
If you have an interest-only mortgage you only pay the interest on your loan each month and not the capital. This means if you started with a £95,000 mortgage, and just paid the interest on it, in 10 or 20 years’ time you would still owe £95,000.
If you have a repayment mortgage, you pay some interest and repay some capital each month. This reduces the amount you owe and means you’re at less risk of negative equity if property prices fall.
Additional secured borrowing
Some people have other borrowing secured against their home. For example, if you had a £95,000 mortgage plus a £2,000 homeowner loan, secured on a £100,000 property, your total borrowing would be £97,000 and your total LTV would be 97%.
Again, this puts you at greater risk of negative equity if property prices fall.
Why does being in negative equity matter?
Negative equity doesn’t matter to a lot of people. If you can afford your mortgage payments and don’t plan on remortgaging or moving home in the near future, being in negative equity won’t cause an issue.
You won’t be threatened with repossession or have to pay extra charges just because you’re in negative equity. As long as you carry on paying your mortgage as agreed, there won’t be a problem.
However, issues can arise if you want to:
- Sell your home
If you’re in negative equity, you’re likely to have issues when it comes to remortgaging. This is because lenders won’t lend you more than the value of your home. So if you owe £95,000 but your house is only worth £90,000, you’ll struggle to find a new mortgage deal.
Selling your home
Being in negative equity will also make it tricky to sell your home.
Your mortgage lender will want the full amount owed to be repaid. If there’s a shortfall between your mortgage amount and the price you can sell your home for, you’ll need a way of paying it off. If you don’t have savings to do this, it might mean you’re unable to sell your home or move house.
How to get out of negative equity
If you are in negative equity, there are a number of steps you can take to get out of it:
1. Make mortgage overpayments
If you have savings or investments, you could put some of this money towards your mortgage. If you don’t have savings to put towards your mortgage, you could increase your monthly mortgage payments instead.
Either way, overpaying will lower your LTV. Check your mortgage terms and conditions before you make a large overpayment – there may be early repayment charges (ERCs) if you’re on a fixed rate, although most lenders allow penalty-free overpayments up to 10% of your remaining balance each year.
If you can’t afford to make overpayments but have a spare room in your house, you could take in a lodger and use the rent to overpay on the mortgage.
2. Sit tight
If you don’t need to remortgage or move house, you can simply stay put and wait for the housing market in your area to improve. House prices go up and down, but over the long-term the trend is normally for house prices to increase, hopefully eventually lifting you out of negative equity.
3. Improve your home
There are some improvements you can make to your home that will increase its value. You’ll need to work out how much the work will cost, and by how much it will inflate your home’s value, before deciding if the investment is worthwhile.