Negative equity is not a position that any homeowner wants to find themselves in. But it can happen. We take a look at what negative equity is – and how to avoid it.
What is negative equity?
Negative equity is when the value of your home is below the amount that you owe.
Basically, if you bought your home for £100,000 with a mortgage of £95,000 and the property is now only worth £80,000, you would be in negative equity.
It typically occurs when there are falling house prices and people have borrowed at a high loan-to-value (LTV). If you only have a small stake in the property to begin with, and a large amount of debt, then you run the risk of negative equity if house prices drop.
What’s the impact of being in negative equity?
If you don’t need to sell or remortgage, being in negative isn’t necessarily an issue – as long as you keep up with your mortgage repayments.
It becomes a problem when you want to sell your house. This is because there is a gap between the value of your home and the amount you owe to pay off your mortgage. Unless you have savings to plug that gap, you could be a little stuck.
If you have negative equity and want to remortgage, lenders are unlikely to let you switch to a new mortgage deal when your existing one ends. Instead, you’ll probably to be moved onto their standard variable rate.
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Depending on the market at the time, the standard rate could be relatively low. But it could also change at any time. This means you could face a sudden increase in your mortgage payments.
How will negative equity affect your finances?
In terms of your day-to-day finances, as long as you keep up your mortgage payments, negative equity isn’t necessarily an issue. You won’t be threatened with repossession or extra charges because of it.
However, if you end up moving to a lender’s standard variable rate when your deal ends, your interest rate could rise.
What can you do about it?
There are three main options for dealing with negative equity:
- Overpay your mortgage: If you are worried that what you owe is more than the value of your home, then focus on bringing the debt down. You can do this by overpaying your mortgage. Ask your lender if you can do this and whether your deal has any early repayment charges. If it doesn’t, you could look to pay more off in a lump sum or alternatively pay a bit extra each month.
- Make some home improvements: Some home improvements can increase the value of your home. Naturally, you would need to weigh up whether the cost of the changes needed to bring you out of negative equity are affordable and worth it.
- Do nothing: Whether or not you are in negative equity will depend on the value of your home. So if you’re in no rush to move, you can just sit tight and wait for house prices to improve.
How can you avoid it?
Being conscious of things like negative equity can only help your financial decision making.
If you are looking to buy a home, make sure to pay attention to what house prices in the area are doing. If the rise in prices is slowing, it could indicate that there’s about to be a drop in prices. It may be best to avoid taking out a mortgage with a high LTV if this is the case.
Meanwhile, if you are already a homeowner, then try building up equity in your home. As mentioned, you can do this by overpaying your mortgage or making improvements that add value.
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