If the amount you owe on your mortgage is more than the current value of your home, you’re in what’s known as “negative equity”.
Soaring house prices in many parts of the UK in recent years mean that negative equity is thankfully not very common these days, but it’s still a good idea to understand how it works and what you can do about it should you ever find yourself in this position.
In this article, we explain why negative equity can be a big problem for homeowners, and provide a few potential solutions and resources to help if you’re affected.
What is negative equity?
Negative equity is when the value of your property falls below the amount of mortgage still owed on it. House prices are always prone to rising and falling, typically going up during periods of strong economic growth when people can afford to spend more on property. Even when a house has been bought and is no longer on the market, that property still has a market value, corresponding with market trends in the area and how well the property has been maintained.
Negative equity used to be a bigger problem several years ago when lenders offered much larger mortgages, often up to 100% of the property value. Nowadays, most lenders will lend no more than 90% or 95% of the property value, and have also tightened up on their mortgage eligibility criteria, so the risk of negative equity has been greatly reduced.
If you’re looking for mortgage advice, you can speak to a Rest Less Mortgages advisor and get high quality advice on residential, retirement interest-only, equity release and buy-to-let mortgages.
Bear in mind there are no guarantees that property prices won’t fall sharply in future, so it’s worth trying to reduce your mortgage (we explain how to do this later) or, if you’re hoping to buy, to put down as big a deposit as possible so that you own a bigger proportion of equity in your home.
How does negative equity happen?
You may find yourself in negative equity if the value of your property falls. For example, let’s say you take a £110,000 mortgage out on a house worth £120,000. If your property price falls to £90,000 over the next five years, but you still owe £100,000 on your mortgage, the amount you owe is now greater than the current value of the property. Specifically, you would be in £10,000 negative equity (£90,000 – £100,000).
How can I find out if I’m in negative equity?
If you are concerned that you might be in negative equity, start by contacting your lender to find out how much you still owe on your mortgage. You should be sent an annual statement which gives you this information. Then, you will need to find out the current value of your property. The best way to do this is by consulting a local estate agent or a surveyor, who will give you an estimate.
If the amount that you owe is greater than the estimated market value, then you are in a position of negative equity.
Why is negative equity bad?
In some cases, being in negative equity might not matter much at all. You won’t have to pay extra charges, and as long as you continue to pay off your mortgage as agreed, it shouldn’t be an issue. It can cause problems, however, if you were hoping to sell your home or remortgage in the near future.
Remortgaging typically involves getting a new mortgage to pay off your old one, but this won’t be possible if your home is in negative equity. This is because the amount still owed on your current mortgage would be greater than the value of your property, and you usually need at least 5% equity in your home to be able to remortgage.
Moving house if you’re in negative equity
It also makes selling your home problematic. Typically, you would use the money from selling your home to pay off the remainder of your mortgage, but if you are in negative equity, then this will not be enough. If you don’t have savings available to make up the difference, then you could be left unable to sell your home or move house.
What can I do about negative equity?
Overpaying your mortgage
If possible, then you could attempt to pay back more of your mortgage every month in order to reduce and eventually eradicate your negative equity. Make sure that you check that your mortgage provider will allow you to do this, and if so, how much they will allow you to overpay without incurring early repayment charges. As a general rule, most lenders will allow you to repay 10% of your mortgage balance each year without penalty. Find out more about making mortgage overpayments in our article Should I consider overpaying my mortgage?
Renting out your home
If your lender and insurer agree, then you could consider renting out your home to supplement your income and pay off your negative equity. This will allow you to keep your current mortgage, though your interest rate may increase. Under the government’s Rent a Room scheme, you can earn up to £7,500 tax-free each year from renting out one or more furnished rooms in your home. If you earn less than this from letting out a room, you don’t need to do anything.
Improve your home
Another option could be to increase the value of your property by making improvements to it. Of course, this usually comes with its own expenses, so it would be a good idea to do your research first and work out whether the time and money investment will be enough to boost the value of your home. Usually, any money spent on improvement might be put to better use paying down your mortgage instead.
Negative equity mortgages
A select few lenders offer negative equity mortgages, which will allow you to get a new mortgage while transferring your debt from the old one. In other words, the negative equity moves with you. However, these mortgages often come with high interest rates, and you may face early repayment charges on your existing mortgage.
Wait it out
If you are not in a hurry to move or remortgage then it could be worth sitting tight and waiting for property prices to recover. This can of course be risky, as house prices could continue to drop. However, you may reach a point where your home’s value has improved enough – or you have paid off enough of your mortgage – to no longer be in negative equity.
Another major downside of waiting it out is that after your mortgage deal runs out, you may be stuck paying hefty standard variable rates for a long time until prices pick up.
Can I go into negative equity if I’ve released equity from my home?
Provided you choose an equity release scheme provided by a member of the Equity Release Council, the trade body for the equity release sector, it must provide you with a “no negative equity guarantee”. This means that if house prices fall and your property ends up being worth less than your outstanding loan, you won’t have to pay any more. Your plan must also provide you with the right to remain in your property for life or until you need to move into long-term care, regardless of what happens to property prices.
You can find out more about equity release in our guide Equity release: What is it and how does it work? Equity release might be an option for you if you don’t have any dependents you want to leave an inheritance for, or enough income to cover mortgage interest payments, and want to access some of the wealth tied up in your property. However, you must seek professional advice before taking out an equity release plan. You can find an advisor through the Equity Release Council.
If you’re looking for somewhere to start, you can get expert advice from a Rest Less Mortgages equity release specialist. They are active members of the ERC and can advise on equity release mortgages from the whole of the market. They’ll listen to your needs and talk you through your options, so you can decide if equity release is the right option for you.