Negative equity occurs when the market value of a property falls below the value of mortgage and other loans secured on that property. Until the onset of the so-called "credit crunch" that started in the sub-prime mortgage market in the United States in the middle of 2007, house prices rose much faster than inflation. It was such that 100%, 110% or even 125% mortgage loans were readily available. The problem with this level of lending, however, is that if housing prices fall rather than rise, as they have done relentlessly throughout the course of 2008, negative equity is effectively "built in" to the mortgage loan. This has already created a problem for thousands of homeowners in the United Kingdom and with housing prices still in decline; thousands more will face negative equity in the near future. Where the housing market will eventually bottom out is really anyone's guess, but the most pessimistic estimates suggest a fall of 30% from the 2007 peak.
Negative Equity Considerations
LTV, or "Loan to Value", as the name suggests, is the proportion of the market value of a property that you borrow with a mortgage loan. In other words, the market value minus any deposit that you able to raise, expressed as a percentage. If you buy a property valued at £160,000, for example, and are able to raise a deposit of £16,000, your LTV is calculated as 144,000/160,000 x 100 = 90%. The higher your LTV, the more equity your home loses as housing prices fall, and many homeowners with little or no equity in their homes are struggling when it comes to re-mortgaging. All the major lenders have withdrawn their 100% or more mortgage products, 95% mortgages are few and far between, and the credit crunch has meant that lenders have tightened their lending criteria and become much more cautious about who they will lend to. Coupled with a 16% fall in housing prices in a 12-month period, this means many homeowners who want or need to sell their home, perhaps because they are experiencing difficulties in keeping up repayments on their existing mortgage loan, or perhaps they need to move home for work, are hindered in doing so. Negative equity does not mean that your home is at risk of repossession, however; it simply means that if you have an existing, fixed-rate mortgage deal, you may find it difficult or impossible to switch to a new lender at the end of the fixed-rate period because 100%+ mortgage deals no longer exist.
Negative equity is only an issue if you need to sell your property. If you cannot afford to re-mortgage at the end of your existing mortgage deal, you may be forced onto the SVR, or "Standard Variable Rate", of your existing mortgage lender, but this is no longer as calamitous an occurrence as it once was. Recent cuts in the Bank Rate means that the SVR of many lenders is in the range of 4.5% to 6%, and while this is not the most competitive rate, it is nevertheless affordable. It is advisable to search the market for a more competitive mortgage deal up to three months before your current deal expires. In any case, a mortgage broker who can offer you deals from the whole of the market and a number of comparison websites can provide assistance in this respect.
If, on the other hand, you can meet your mortgage repayments comfortably and have no need to move in the near future, negative equity may not present much of a problem at all. Housing prices may not start to recover until 2010, or beyond, but if you stay in your current home and possibly make improvements to it in the meantime, capital repayments and recovery in the housing market, are likely to see you freed from negative equity in the long term. Indeed, the number of new houses being built lags significantly behind Government targets, so, in a few years time, there may well be another housing boom. This is all very well, as long as your circumstances remain unchanged while you wait for the housing market to recover. An unforeseen change, such as accident, illness, or redundancy, can affect your ability to keep up mortgage repayments and expose you to the full consequences of negative equity; it may pay to make sure that you are adequately insured against such eventualities.