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The level of equity you hold in your property can make a big difference to your future finances, and your ability to move up the property ladder.
In basic terms, the equity you own in a property is how much of the property you actually own, which is mortgage-free. This home or house equity is worked out as the difference between your property’s value overall and how much you still owe on your mortgage.
Let’s say you buy a house for £200,000 with a £20,000 deposit and a £180,000 mortgage. At this point you have £20,000 of equity in the property. As you pay off your mortgage over time and (hopefully) your home increases in value, the amount of equity you own will go up.
What is negative equity?
Negative equity means that you owe more on your outstanding mortgage than what your property is worth.
It can affect borrowers who only have a limited amount of equity in their home when house prices fall – even more homeowners might be affected if there is a house price crash.
So in our example above, if you pay off some of your mortgage and your outstanding balance is £170,000 but the value of your property drops to £160,000, you will be in negative equity by £10,000.
How to work out if you’re in negative equity
To check whether you’re in negative equity you’ll need to find out:
- How much you owe on your mortgage: Contact your mortgage lender or check your latest mortgage statement.
- The value of your property: Ask an estate agent to value your home or get an estimate via an online valuation.
If the amount you owe on your mortgage is higher than the value of your property, you are in negative equity.
What happens when you are in negative equity?
Being in negative equity isn’t always something to worry about. If you have no plans to move and continue to make your mortgage repayments, you may soon find you’re no longer in negative equity. This could be because you’ve reduced the amount owed on your mortgage, or because there’s been an improvement in the housing market which means the value of your property has gone up. Sometimes, you may escape negative equity due to a combination of both.
Where negative equity does have the potential to cause problems is if you need or want to remortgage or move home.
Negative equity and remortgaging
Being in negative equity can make it more difficult to remortgage, particularly if you want to switch to a new lender.
This is because you can only usually get a mortgage for up to 95% of the value of your property (using a 95% loan-to-value mortgage). So if you’re in negative equity, you may not be able to get a new mortgage which is big enough to cover what you owe.
The inability to remortgage can be costly as once your initial fixed or variable rate ends, you’ll move onto your lender’s standard variable rate (SVR) if you don’t switch to a new deal. The SVR tends to be higher than the rate you’ve been paying, which means your monthly repayments will increase. If you find yourself stuck on an unaffordable interest rate as a result, you’re effectively a mortgage prisoner.
What you can do
If you’re struggling to remortgage because you’re in negative equity, remortgaging with the same lender may still be an option. While you may miss out on better mortgage rates from other lenders, your current lender may still offer you a lower rate than the SVR. Talk to your lender around six months before your existing deal ends to discuss your options.
» MORE: Compare remortgage deals
Negative equity and moving home
Negative equity can be a significant problem if you want or need to move. This is because the money you raise from the sale of your home won’t be enough to pay off your existing mortgage. Instead, you’ll need to find the funds to pay off the shortfall. In turn, this may also affect your ability to raise a suitable deposit for the next property you’re hoping to buy.
What you can do
Some specialist lenders offer “negative equity mortgages”, which allow you to move, but they usually have high interest rates. There may be early repayment charges to pay on your current mortgage too. Alternatively, your current lender may have other options for allowing you to move, if you can meet certain eligibility criteria.
Generally, however, it’s not recommended to sell a property if you have negative equity. If you don’t have the funds and don’t have to move, delaying your plans may allow you to eventually get out of negative equity and make it easier to move in the future.
If you have little option but to sell, and meeting the shortfall would push you into debt or make your finances uncomfortable, speak to your lender and get debt advice before making a final decision.
Will I lose my house if I am in negative equity?
While negative equity can be problematic, it doesn’t mean you will lose your home. Properties are only repossessed if you do not pay off your mortgage. So long as you keep up with your monthly repayments, your property will not be repossessed.
How to get out of negative equity
Here are some of the ways you may be able to build the equity you own in your home and escape negative equity.
Sit tight
It may be possible to get out of negative equity simply by making your normal mortgage repayments and waiting to see if property values improve. It could take a few years to pay a decent amount off your mortgage or for house prices to rise, but if you don’t need to move, patience may pay off.
Make overpayments
If you can pay more towards your mortgage, you’ll bring your mortgage debt down faster, and should see your equity rise. Importantly, you should only overpay on your mortgage if your finances allow it – this is because once your lender has the payment, you can’t usually get the money back.
While most mortgages accept overpayments, always check with your lender exactly what you can do. In particular, find out if there’s a limit on the amount you’re allowed to overpay without incurring an early repayment charge. Often, the most that can be overpaid penalty-free is 10% of your outstanding mortgage balance, so always ask.
Your lender may give you the option to make a lump sum overpayment on your mortgage balance, overpay regularly each month, or use a combination of both.
» MORE: Is it worth overpaying on your mortgage?
Improve your home
Making the right home improvements could add value to your property, increasing your equity. However, careful thought is required, as there is no guarantee that the money you spend will result in a similar or larger rise in the value of your property. Depending on your renovation plans, it may make more sense to use the funds to pay off some of your mortgage directly instead.
» MORE: Remortgaging to pay for home improvements
Rent your property out
If you rent out your property, and can find somewhere else to live that’s cheaper, you may be able to use the money you save to pay more off your mortgage. It could also buy you time to see if the value of your property increases. The main considerations are that you’ll need to get consent to let your property from your lender, and being a landlord can come with higher mortgage rates and extra costs. There’s also the risk your property spends time empty, meaning you’d get no rental income.
» MORE: Where is the cheapest place to rent in the UK?
How to avoid getting into negative equity
When buying a house, there are a few steps you can take that may help you avoid falling into negative equity.
- Save a larger deposit: The bigger the mortgage deposit you can put down, the more you’ll own straight away. This will give you more leeway against falling into negative equity if property values were to fall.
- Only pay what a property is worth: If you get caught up in a bidding war, or pay substantially more than a property is reasonably valued, there’s a greater chance of dropping into negative equity.
- Beware the new-build premium: Buying a brand new home can have a certain appeal, but the premium you’ll often pay for a new-build may make it harder to get the same price or higher if you sell in the next few years.
- House price bubbles: If experts are predicting a correction in house prices, it may pay to think carefully before buying, particularly if you won’t have much equity to begin with.
» MORE: Latest UK house price trends and forecasts
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