In this article, we explain what negative equity is, what causes it and how to work out how much equity you have in your home. We also detail the effects of negative equity and the steps you can take to avoid falling into it.
What is negative equity?
Negative equity occurs when your property value falls below the amount that is left on your mortgage. Negative equity is most likely to impact borrowers in the early years of a mortgage and is likely to occur when property prices fall. Most mortgages are arranged based on a loan-to-value ratio of between 60% and 95%. The loan-to-value, or LTV for short, is calculated by dividing the loan amount by the value of the property. Negative equity occurs when the LTV ratio exceeds 100 percent.
How do you know if you are in negative equity?
You'll need two things to work out if you are in negative equity; an up-to-date valuation of your property as well as the amount outstanding on your mortgage which you can find on your mortgage statement. There are a number of tools that can provide you with a free valuation online or alternatively, if you are interested in selling your property, you can instruct a local estate agent to conduct a free valuation in person.
Once you know the property value and the amount outstanding on the mortgage, you'll be able to work out the loan-to-value ratio that applies to your home. Simply divide the amount owed on the mortgage by the value of your property and multiply the result by 100. So, if you have £200,000 left on your mortgage and your property is worth £250,000, you would calculate the LTV as follows:
- Mortgage outstanding (£200,000) ÷ Property value (£250,000) = 0.8
- 0.8 x 100 = 80
- So the LTV is 80%
Negative equity example
If you calculate the LTV and it works out at more than 100%, then your property is in negative equity. So, if your property is worth £200,000 but you have £250,000 left on your mortgage, you would be in negative equity. An example of a property that is in negative equity is as follows:
- Mortgage outstanding (£250,000) / Property value (£200,000) = 1.25
- 1.25 x 100 = 125
- So the LTV is 125%
How can negative equity affect you?
If your home is in negative equity and you are not looking to sell or remortgage, you are unlikely to feel any impact of the fact that your home is worth less than the amount you owe on your mortgage. Your mortgage payments are unlikely to change if you are in a fixed-term mortgage deal and your lender is unlikely to address the negative equity in your home. Negative equity is only likely to become an issue if you sell or remortgage and at this point, a lender will need to assess your new loan-to-value ratio. If your loan-to-value ratio comes out at more than 100% then you may find it difficult to:
- Secure a new mortgage deal when your old one expires
- Sell and move home
- Afford your monthly mortgage payments based on the standard variable rate (SVR) of interest
What are my options if I am in negative equity?
You may still have a number of options if you find yourself in negative equity, however, these will depend on your personal circumstances. Options may include:
- Reduce your mortgage balance - assuming you have a repayment type of mortgage and do not exceed your mortgage lender's overpayment limits, you can make lump sum and regular payments to reduce your mortgage balance until it is lower than the value of your home.
- Wait for house prices to rise - house price falls can be temporary and so you may find that the value of your home increases after a period of time.
- Improve your home - home improvements can increase the value of your home but you should carry out thorough research to ensure that the home improvements you choose to make, will, in fact, increase the value of your home. You need to ensure that the money is not better spent reducing the balance of your mortgage instead.
- Use your savings to reduce your mortgage balance - if the interest rate that you are being paid on your savings is less than the interest rate charged on your mortgage, it may be sensible to use your savings to reduce your mortgage.
- Downsize your home - you may be able to sell your home, repay what you can of your mortgage balance and move into a lower-value property. This could allow enough room in your affordability budget to repay the remaining balance of your existing mortgage, however, this could impact your credit score and so needs to be considered carefully and usually as a last resort.
- Sell up and move into rented accommodation - you may wish to sell your home and repay as much of your mortgage as you are able to and rent while you repay the remaining balance. Do remember that rent for a similar property may well be more expensive leaving you with little or no budget to afford a payment plan.
- Switch to a repayment type of mortgage if you are only paying interest - if you have an interest-only mortgage, your monthly payments are not reducing the mortgage balance so the difference between the value of your home and your mortgage balance will only change if your house increases in value. Switching to a repayment mortgage will help you to reduce your mortgage balance, so long as you can afford the higher payments.
Do contact your lender to understand all of your options before taking action or speak to a mortgage broker who can weigh up the pros and cons of different options to help you decide the best course of action. Often early repayment charges will need to be considered if you switch mortgage deals or move your mortgage to a new lender.
How to avoid falling into negative equity
Buying a house is usually one of the largest purchases you're likely to make and negative equity could be one of the worries you have when you do so. So, it is helpful to understand that the closer your mortgage loan amount is to the value of your home, the more you are at risk of negative equity. Buying a property with a high loan-to-value could mean that even a slight fall in your house value could increase your LTV ratio to over 100%. To avoid falling into negative equity, you should ensure that you:
- Pay as large a deposit as you can to increase the amount of equity in your property
- Choose a repayment type of mortgage to gradually increase the equity in your property
- Pay a fair market value for your home and ideally avoid buying at the height of house prices
Although you may be limited in the amount that you can afford to pay as a deposit, there are ways to ensure that you pay a fair market price for your property and avoid paying over the odds. Regardless of how much you think a property is worth to you, eventually, it will matter what others are willing to pay for it, so don't pay more.
Check local house prices by searching for "sold house prices" online to ensure that you are paying a fair price. Be careful to compare similar homes that have sold recently to get the best comparison results. You can read more about how to do this in our article, "Negotiating house prices: How to get the best price".
If you find yourself in negative equity you may not have to do anything at all. Often, house prices will rise again when the housing market recovers and solve the problem before it affects you. However, if the timing of a fall in housing prices coincides with the end of your mortgage deal or plans to move house, it can limit your options to remortgage or sell your property. A negative equity mortgage can be difficult to arrange but there are solutions that you should explore to give you the best outcome.
The best thing to do is to speak with your mortgage broker to discuss your options. If you do not have a mortgage broker, you can source a local mortgage broker using VouchedFor*, a service that vets financial professionals in your area. Alternatively, we have vetted the services provided by the online mortgage broker, Habito* - the mortgage brokers at Habito are knowledgeable and with access to over 90 lenders, they are well-placed to source a mortgage for a wide range of borrowers.
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