Negative Equity And How You Can Avoid It

Negative equity occurs when you owe more on your mortgage (and in secured loans) than your home is worth. This usually occurs due to falling house prices, and with the UK housing market seemingly on the downturn, the problem could become widespread in the near future.

A recent BBC report estimates that 23,200 people with 100% mortgages (in which no deposit is put down) could face negative equity in the next year.

Even homeowners who have put down a deposit are at some risk – the smaller the deposit, the bigger the risk of falling into negative equity.

Negative equity is a particular problem if you are looking to move home. It means that you couldn’t pay off your mortgage by selling your home – and that makes moving up on the housing ladder very difficult.

How can I avoid negative equity?

There are a few things you can do to avoid (or lessen the impact of) negative equity:

Put down a higher deposit when you buy
The higher your deposit, the more (positive) equity you have, and the less chance you have of falling into negative equity.

For example, if your home’s value falls by £15,000 but you had only put down a £10,000 deposit, you will have £5,000 of negative equity. If you had put down a £20,000 deposit, you would still have £5,000 equity.

Pay more towards your mortgage (repayment mortgages only)
The faster you pay your mortgage back, the faster your equity grows, and the lower your chance of falling into negative equity.

While mortgage terms vary, the vast majority last between 15 and 40 years. The shorter your repayment period, the faster you pay the mortgage back – and the faster your equity grows.

Also, many banks will allow you to make overpayments: a good way of increasing your equity more quickly without committing to the higher payments of a shorter repayment term.

Convert your interest-only mortgage to a repayment mortgage
Interest-only mortgages are particularly vulnerable to falls in house prices. Because lenders expect the full mortgage amount back when the house is sold, any fall in value would need to be accounted for by you – potentially landing you in debt.

Interest-only mortgages are tempting due to their lower monthly payments, but you do not gain equity through making the monthly payments, as the actual value of the house is not paid back. Consider a remortgage – often, repayment mortgages are not much more expensive, and the growing equity could be invaluable if house prices do fall.

Make home improvements
The right home improvements could increase your home’s value, meaning the market value would have to drop further before your home would go into negative equity.

However, be aware that certain home improvements do not return as much in value as they originally cost – in which case it would be better to save the money!