What is negative equity?
Many people see buying a home as an investment in their long-term financial future.
This is because home values in the UK have risen steadily in most areas since the financial crash of 2008. As the value of the property grows, so does the share of the property you own - known as your 'equity'.
But like any investment, there's no guarantee of growth. House prices have decreased at various times in the UK - and if this happens while you own a property, it may be worth less than what you owe on your mortgage, a situation known as 'negative equity'.
Which? Mortgage Advisers can help you switch to the best available deal.
How do I calculate the equity in my home?
When you first buy a property with a mortgage, your equity will be the deposit you put in - for example if you buy with a 20% deposit, your equity will be 20% of the home's value.
Your equity can increase in two ways:
- As you pay back the mortgage, the share of the property you own will increase.
- If the property grows in value, the loan will account for a smaller percentage of the property's value.
So, to work out your equity, take the amount the property is currently worth, then subtract the outstanding loan on your mortgage - which will be the original price you paid, minus your deposit and repayments.
Equity = current value minus outstanding loan amount
If this amount is below zero, your property is currently in negative equity.
Say you buy a £200,000 home with a £20,000 deposit - meaning the loan when you buy is £180,000.
After five years, you may have seen the property value increase by 25% to £250,000. You've also repaid £25,000 in that time, meaning your outstanding loan is now £155,000 - so your equity would be £95,000.
But if prices decreased by 25%, your home would now be worth £150,000, even though you still owe the bank £155,000. In this situation, you would be in negative equity by £5,000.
Am I at risk of negative equity?
Home values fluctuate, so don't panic if average prices in your area drop by a percentage or two.
Even if your property's value decreases slightly, it would need to drop by more than the amount you've paid in deposit and repayments for you to be in negative equity.
That said, market crashes can happen. Following the financial crisis of 2008, the average house price in England fell from £188,657 to £159,340 - a drop of 15% in one year.
Of course, an average price is a guideline only, and may not reflect house price activity in a particular area or even street.
The graph below shows average prices in the UK since 2005.
If home values in your area do decline, you'll be most at risk in the following circumstances:
- You've only recently bought your home, so your only equity is the deposit you paid.
- You bought with a 95% or 100% mortgage, meaning your only equity is your repayments and capital growth.
- You paid a premium for the property, either by over-paying or buying when prices hit a peak.
- You bought with an interest-only loan, so are reliant on capital growth to build your equity.
- The area you bought in is suffering from a long-term economic or property market slowdown.
- Something happens to the property to drastically reduce its value.
Find out more: how much is your house worth?
How will negative equity affect my finances?
Being in negative equity can put you in a tricky financial situation.
If you were to sell your property, you wouldn't make enough to repay your outstanding loan to the bank and would continue to owe money.
If you wanted to remortgage, the lender would be unlikely to approve a new deal, as your property would not be sufficient security. This means you'll likely be stuck on the lender's standard variable rate when your deal expires.
That said, negative equity won't necessarily impact on your credit score, unless you default on your payments or need to move house and cannot make up the shortfall.
If you're able to stay in your property and continue meeting your mortgage payments each month, negative equity may not affect your everyday finances.
What can I do if I'm in negative equity?
The options available to you, if you've fallen into negative equity, will depend on your personal circumstances, and what you hope to do in the coming years.
If you're able to stay in the property and meet your repayments
In this situation, your best bet may be to continue making repayments, which over time will build up the equity you hold.
You might also consider making over-payments, if your mortgage deal allows it, which would bring down your loan more quickly. Mortgage rates tend to be higher than savings interest, so you might be better off putting some cash into your mortgage loan.
Over the long term, prices may begin to rise again and help reduce the level of negative equity or even reverse it.
It may also be possible to add value to your property by renovating or adding features that are in demand in your local market. But this can be highly risky - you could spend more on renovations than the value that you gain. In most cases, your cash is likely better used paying down the loan.
If your mortgage deal expires
Normally, when your mortgage deal comes to an end, it's wise to consider remortgaging - but while it's worth trying this, lenders may not offer you a new deal if you're currently in negative equity.
This means you'll move onto the lender's standard variable rate (SVR), which will generally be higher, meaning your repayments will go up.
As your deal is coming to an end, make sure you can continue to meet the new payments on the SVR over the long-term.
Our mortgage repayments calculator shows you how interest rate changes will affect your monthly repayments.
If you need to move house
If it's at all possible, you should avoid selling your house while in negative equity - if you're forced to sell for less than the loan amount, you'll be responsible for making up the shortfall.
That said, your mortgage lender may allow you to repay the debt over time using a payment plan, so it's worth talking to them before you sell.
Keep in mind that selling while in negative equity will mean you won't make a profit and will lose the deposit you paid - so you may not be able to buy a new property straight away.
A very small number of specialist lenders offer 'negative equity mortgages', which enable you to transfer the negative equity to a new property, saving you from repaying the debt. But you might face early repayment charges on your old mortgage, and the interest rates are generally very high.
Another option if you need to move is to let out your property and rent elsewhere. But you'll be responsible for meeting repayments when the property is vacant, as well as paying rent at your new place, which could put you in a worse financial situation.
If you can't meet your repayments
If you're struggling to meet your mortgage payments, contact your lender immediately. They may offer options that would make your repayments more affordable.
In the meantime, continue paying what you can. 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.
In the worst case scenario, the lender may repossess your home. Your home will then usually be sold as quickly as possible, often for less than the market value, meaning you'd owe the bank even more than you would have if you'd sold the property yourself.
- Find out more: what to do if you're struggling to pay your mortgage.
Negative equity and Help to Buy
Under the Help to Buy equity loan scheme, the government lends you 20% of the purchase price of the property (40% in London) in exchange for a share of the property. The first five years of the loan are interest-free.
You need to put down a 5% deposit and then take out a mortgage for the remaining 75% of the property value (or 55% in London).
Any time you buy with a small deposit, even a relatively modest fall in house prices could quickly erode the equity you hold.
That said, if you fall into negative equity with a Help to Buy loan, you may be slightly better off than with a 95% mortgage.
That's because the government owns a percentage share of your property, rather than a set monetary amount. This means that if your property value drops from £200,000 to £150,000, the amount you'd owe on a 20% Help to Buy equity loan will also fall from £40,000 to £30,000.
- Find out more: Help to Buy equity loan
Guarantor mortgages and negative equity
As first-time buyers struggle to get on the property ladder, many are turning to guarantor or family mortgages.
These types of deals allow a family member to offer their house or cash savings as security, and the buyer to take out a 100% loan.
With no deposit, you're at higher risk of slipping into negative equity, especially in the early years of your mortgage before you've made significant repayments.
If you are forced to sell while in negative equity, or your home is repossessed, your family member will be liable for meeting the shortfall - which may cost them their own home.
For this reason, you should be careful to ensure you can meet your repayments, and that you're unlikely to be in a situation where you have to sell for less than the asking price.
- Find out more: guarantor mortgages
Buy-to-let and negative equity
Capital growth is part of the allure of buy-to-let - rent provides the investor a long-term income, while the asset itself grows in value.
For this reason, many investors buy using interest-only loans, meaning they don't repay the capital on the property, just the interest. In theory, the rent generated pays off the interest each month, while capital growth increases the investor's share of the equity.
If the property value fails to grow, your share of the equity won't increase, limiting your chances of remortgaging or paying off the loan.
You also won't have equity from the property to finance the next purchase and grow your portfolio, a common strategy.
That said, rents don't necessarily track with capital growth, so you may be able to continue letting out the property and repaying the interest until the market picks up again.
- Find out more: buy-to-let mortgage calculator from Which? Mortgage Advisers
How do I avoid getting into negative equity?
If you're concerned about negative equity, there are a few steps you can take:
- Do your research to make sure you're paying fair market value for a property.
- If the market is especially 'hot' - meaning prices are at a peak - consider delaying for a year or two until activity slows.
- Put down as large a deposit as you're able.
- Avoid interest-only deals, even if the repayments are attractively low.
- Consider over-paying your mortgage, if your deal allows for it.
- Remortgage when your deal expires so you're always paying the best rate.