Escaping The Negative Equity TrapPosted on: 13 July 2009 by Gareth Hargreaves
Almost one in six 'prime' UK mortgages have plunged into negative equity during the property crisis, new figures from ratings agency Fitch have revealed.
This means even the most sensible homeowners could now owe more money than their home is worth.
If you find yourself in this situation, don't panic. Hundreds of thousands of borrowers have safely navigated their way out of negative equity, and there's no reason why you can't too.
To help you on your way, we've put together a guide containing all the vital information you need to keep hold of your home.
How It All Started
Before the credit crunch, negative equity was largely regarded among homeowners as the property equivalent of typhoid. That is, something really nasty that happened to people a long time ago but was now thankfully extinct.
But when Northern Rock was bailed out by the government in 2007 and economic chaos ensued, that view was turned on its head. Since then, the price of the average UK home has plummeted from £201,000 to its current £158,000, according to Halifax: a drop of around 21%.
The most likely victims have been recent first-time buyers who took mortgages worth up to 100% of the property's value, only to see prices fall faster than they could reduce their outstanding debt.
Longer-term homeowners have also felt the pinch, especially those who borrowed back against the rising value of their homes during the 'golden' years of the property boom.
What Negative Equity Means To You
As we mentioned at the start, it's never a good idea to panic. First of all, if you don't need to move home and can afford your mortgage, then negative equity is totally irrelevant.
Second, mortgages are far more affordable today than in the last recession. "In the last recession, base rate jumped quickly to 15% which no homeowner budgets form," explained Ray Boulger, senior technical director at broker John Charcol.
"Today's borrowers - especially those on tracker and variable rate mortgages - have a better chance of repaying their mortgage even if their circumstances do change."
Taking Back Control
You could also take action and fight against negative equity. Most mortgages have an overpayment facility in place which means you can whittle away your debt far quicker.
"The vast majority of lenders allow borrowers to overpay by 10% of the outstanding debt each year or by a straight £500 a month," said Melanie Bien, director at mortgage broker Savills Private Finance.
Taking this opportunity would help eat into your negative equity and save you a fortune in interest. For example, let's assume you had a 25-year repayment mortgage of £100,000, payable at a rate of 4.5%. Should you choose to pay an extra £50 a month, you would save a staggering £10,571 on the total cost of the loan and be mortgage-free three-and-a-half years early.
Overpaying on your mortgage in a race to beat negative equity works best in tandem with a recovering property market. Many experts think house prices have now bottomed out, with reports from both Nationwide and Halifax indicating that the average property value increased by 1.2% and 2.6% respectively in May.
That said, one month of good news does not spell an end to market troubles. "Historically, house prices have not moved in the same direction month after month even during a pronounced downturn," said Halifax economist Nitesh Patel.
"For example, prices fell by 11% nationally during 1991 and 1992, but there were five monthly price rises in this period."
In the long-term though, house prices to date have only gone up. According to Halifax, house prices in all UK regions have doubled over the past decade. These Increases varied from 101% in the South East to 155% in Northern Ireland.
If you need to move house, things could get a little trickier. The only watertight way to sell a home with negative equity is by having enough savings to bridge the financial gap.
This may sound daunting but the majority of negative equity cases (two-thirds) are currently only facing shortfalls of around 10%, which equates to between £6,000 and £8,000, according to the Council of Mortgage Lenders.
If you have no savings but still need to move, you might be able to negotiate with your lender to transfer the shortfall onto an unsecured loan. "This arrangement happened a lot in the 1990s and, although is less common now, it's certainly worth a try," said Boulger at mortgage broker John Charcol.
These options only work on the basis that you were selling your home to rent rather than buy another one. Buying would mean raising at least a 10% deposit on the new property in addition to the equity shortfall and associated moving costs.
If this tactic falls flat, there is also the option of renting out your home and moving to another one.
The most recent lettings survey from the Royal Institution of Chartered Surveyors shows 42% more surveyors reported a rise in new tenant lettings in quarter four of 2008 than on the previous quarter. Many of these are "reluctant landlords" who simply can't afford the mortgage and have to find somewhere cheaper to live.
Provided you demonstrate clearly to your mortgage lender that you are not letting your home for commercial gain, it may agree to "consent to lease". This means you could stay on a residential mortgage rather than being transferred to a more expensive buy-to-let deal.
Terms and conditions among lenders vary but it is likely you would be charged a fee of between £100 and £300 and asked for proof of rental income, such as an Assured Shorthold Tenancy Agreement. The move would have to be temporary, say for 12 months, and the rent might also need to total up to 125% of the mortgage repayment.
If you want to stay put in your home but remortgage away from your lender to a better deal you have found elsewhere, being in negative equity would pour cold water over your plans.
This is because no new lender would take on a mortgage debt that is greater than the value of the security on which it is lent.
"Lenders won't let you remortgage to them if you are in negative equity," said Bien. "Maximum loan to values are 95% of the property value, although some lenders won't even go this high."
This leaves little other option than to revert to your lender's standard variable rate. According to financial data provider Moneyfacts, the average SVR is 4.61% and experts predict that the base rate - to which SVRs are loosely linked - could remain low into next year.
Switching Deals With The Same Lender
However, while there are no tie-ins or penalties with an SVR, your lender could hike its rate at any time: remember that it's not tied to the base rate.
If this concerns you, it's worth asking your lender to switch you to another deal - such as a fixed rate - in spite of your negative equity. This is known as a product transfer and while most lenders are unlikely to agree you might have some luck.
"Halifax and Bank of Scotland, for example, will allow existing customers to take another deal on a loan of up to 120% of the property value," said Bien.
Recent reports have even found homeowners in particular financial hardship could be offered cheaper rates than those with a 15% deposit.
Hanging In There
Lastly, when times are tough, console yourself with a history lesson. At the depths of the last recession in 1993, 1.5 million households were estimated to be in negative equity.
With their homes having more than double in value - and many mortgage-free entirely - you can bet those who opted to hang on are thankful they did.
What to do if you are in negative equity
- Staying put: if you can afford your mortgage comfortably and don't want to move, negative equity won't affect you. Besides which, no lender would allow you to trade up the ladder and take negative equity with you anyway.
- If you want to sell: if you are desperate to sell, your lender might consider transferring the shortfall to an unsecured loan. Note that you won't be able to buy somewhere else to live.
- If you need to move: consider renting out your home and renting yourself elsewhere.
- If you see another lender offering a better rate: you will not be able to remortgage to another lender with negative equity. Lenders require at least a 5% deposit and usually more.
- If you want to switch to a different deal with the same lender: most won't play ball, but some lenders will allow you to take another deal at 120% of the current property value. It's worth a go.
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