How You Could Lose Your Home

As I explained in Lessons From The Last Housing Crash, I personally witnessed homes being repossessed in the last property crash.

In the early Nineties, I was working in the legal department of an insurance firm. Now and then, I would attend court to confirm that a homeowner's mortgage payment protection insurance claim was invalid, or that their monthly benefits had expired. Once this safety net had failed, homeowners often had no choice but to surrender their homes to their mortgage lender, which was a sad sight to see.

The good news is that repossessions have plummeted since the bad old days of 1991, when 75,540 properties were seized by lenders, throwing around 250,000 people out of their homes. Indeed, partly thanks to the latest property boom, lenders grabbed a mere 6,030 homes in 2004 and just 10,250 in 2005. However, even the most optimistic property bulls are expecting repossessions to rise this year and next, perhaps by an extra 2,000+ cases per year.

So, what causes someone to lose the roof over their head? The simple answer is that they fail to keep up their mortgage repayments and, once they are a certain number of months in arrears, their mortgage lender begins recovery action against them. Ultimately, unless the agreed payment terms are stuck to, the lender begins court proceedings to take possession of the property.

Fortunately, the majority of possession orders are suspended, and borrowers often do get things back on track. Alas, some homeowners do fail to prevent the worst and end up losing their pride and joy, to be sold at a knock-down price.

So, the big question is: what causes borrowers to go into arrears in the first place? To find out, I turned to a leading mortgage-counselling firm, White Horse Mortgage Services, which produces an annual survey of mortgage arrears. Here's what the company's latest report reveals:

So, as you can see, almost a third of mortgage arrears (31%) are caused by homeowners earning a reduced income -- mostly caused by lost overtime or bonuses, or being transferred to lower-paid or part-time work. The best way to avoid this trap is to make sure that you have sufficient savings in a Best Buy high-interest account to pay, say, three to twelve months' mortgage repayments.

The second-biggest cause of mortgage arrears is entirely preventable: financial mismanagement, or the simple inability to make ends meet or budget properly. Shocking isn't it, that two in nine cases of arrears are caused by sheer negligence? If you want to avoid this problem, the simple answer is to learn to budget!

Unemployment accounts for almost an eighth (12.1%) of mortgage arrears, with ill-health following close behind on 11.6%. To avoid these risks, you can buy accident, sickness and unemployment (ASU) insurance, either linked to your mortgage or as a stand-alone policy. However, don't buy this protection from your mortgage lender, or you'll pay premiums two or three times higher than those charged by a Best Buy policy. Then again, for most workers, income protection is often a better bet.

Finally, with unemployment climbing for ten months in a row, I expect this problem to have a bigger impact in 2006 than in recent years. Also, arrears due to over-indebtedness are rising fast, almost doubling between 2003 and 2005. Is it any wonder that debt is damaging our finances, given that the typical household now has almost £8,000 of non-mortgage debt? Ouch!

To dynamite your debts, read Ten Ways To Dump Your Debts and Twenty Steps To Debt Freedom, and get help in our Get Out of Debt centre and Dealing with Debt discussion board.

More: Apply for super 0% credit cards, Best Buy personal loans and top savings accounts via the Fool!