Recent headlines have been full of the term 'negative equity' and they often give the impression that negative equity is a fate worse than death. But let’s be honest, it’s not.
Negative equity is when your house is worth less than the mortgage secured on it. So negative equity is just a notional value and doesn’t exist in reality unless you try to sell your house. Obviously if you are in negative equity and you want to ‘sell up’ then the sale proceeds from your current house won’t be enough to repay your mortgage, let alone give you anything to put towards your next home. In this instance the bank would want the balance of the money you owe. So unless you have a lot of money in the bank then you’re not realistically going to be moving anywhere.
As long as you can afford your monthly mortgage payments negative equity simply limits your options in terms of mortgages and moving. You will not get repossessed or any other nonsense.
If you are in negative equity the first thing to take on board is that you are not alone. Recent research has suggested that more than 350,000 home owners who bought in 2007 (the top of the market) are now in negative equity. (Although this is someway off the pessimistic prediction of 1.2 million made by Morgan Stanley in September 2010). And to make you feel even better I bought my house in 2007.
But feeling better about the situation is one thing but is there anything you can do if you are worried about negative equity?
What to do about it
Below I’ve listed a number of steps which could help reduce your chances of slipping into negative equity, or if you are in there already – get out of it.
Obviously I’m making the assumption that you can afford your monthly mortgage payments.
If you think you might go into negative equity get a repayment mortgage – if you are on an interest only deal yet can afford to move on to a repayment mortgage then you may want to consider switching - assuming you are able to secure a new deal. Under an interest only mortgage you monthly mortgage payments simply clear the interest charged by your lender, but your outstanding mortgage debt is not reduced. In simple terms the only way to get out of negative equity is for your house price to rise above the amount you owe or to reduce the amount you owe. With a repayment mortgage you are not only paying the interest on the borrowed money but clearing your debt at the same time. So at the end of the mortgage term the debt is cleared. By going on to a repayment deal, admittedly your monthly mortgage payments will go up, you will save thousands of pounds on interest payments as well as reduce your mortgage. This will obviously reduce the chances of you slipping into negative equity.
Overpay your mortgage – if you are already in negative equity (or again worried about dropping into it) overpaying your mortgage will reduce your mortgage debt and help restore the parity between your house price and what you owe. But speak to your lender first before doing anything as there will usually be a maximum overpayment limit after which you will get charged.
Put your feet up – as I said negative equity essentially limits your options and if you don’t plan to move home or remortgage anytime soon it’s largely irrelevant as long as you can afford your mortgage payments
Save – while negative equity reduces your options, you can counteract this by saving money. This is useful for people who may not plan on moving anytime soon, or who are already overpaying their mortgage by the maximum amount allowable but who want to do more. Ultimately you could use this money to boost your equity content if you decide to move or remortgage.
A spot of DIY – boosting the value of your home is the other more tricky option. A pound spend on reducing your debt has an immediate effect. But a pound spent on home improvements will not necessarily add a pound of value to your property. So while a spot of DIY can help boost your home’s value its impact is a bit hit and miss. Also large scale projects could actually leave you with a net loss upon selling.