Most property purchases today require a substantial deposit, but an estimated 500,000 homeowners in the UK have negative equity. But what exactly is negative equity? Keep reading to know more about negative equity and its impact.
What is negative equity?
When the value of your property is less than the mortgage on it, you have negative equity. The term ‘equity’ refers to your investment in the property, including your initial deposit and any mortgages you have paid off. Therefore, the equity in your home will be low if you only pay a small deposit and make marginal mortgage payments. A professional estate agent may be able to provide you with a free accurate house valuation in order to determine how much negative equity you have in your property.
For example, let’s say you bought a house for £200,000. In most cases, you pay a 5% deposit (the minimum deposit amount) of £10,000. The remaining £190,000 is covered by a mortgage, with interest-only repayments. Until you repay the capital sum of your mortgage, your equity is only £10,000. It will not grow, which means if the value of the property falls, you might find yourself in a position of negative equity.
What causes negative equity?
Negative equity occurs when the value of your home falls below what you owe on it. You may have acquired negative equity for various reasons, including a fall in property values, changing interest rates, unemployment, or foreclosure. Negative equity can also occur if you purchase an overpriced home relative to the market.
The impacts of negative equity:
Negative equity can negatively affect buyers in many ways. Some of these include:
- Difficulty finding additional financing: If you have negative equity, you may have difficulty obtaining a mortgage or home equity loan.
- Lower selling price: To recover negative equity, you’ll have to lower the asking price for your home.
- Loss of bargaining power: A seller with negative equity may have to accept a lower offer.
- Lower monthly payments: To make the sale, a seller with negative equity may have to settle for a lower monthly payment.
The long-term impacts of negative equity:
Negative equity may affect your credit score and hinder your ability to qualify for a loan in the future. If you have negative equity in your home, the amount of credit available may reduce. If your debt exceeds a certain percentage of your credit limit, it can negatively affect your credit score. Even if you can qualify for a loan with negative equity, it can be challenging to qualify for a loan in the future.
Negative equity can also cause problems if you decide to sell your home in the future. Potential buyers may be unwilling to buy a home with a large amount of negative equity as they may not be able to refinance the mortgage.
The consequences of walking away from negative equity:
If you walk away from a mortgage, you’ll be considered a “defiant homeowner” in most states and lose your right to the property. This means that creditors can take the house to satisfy the debt, whether you owe them money in particular or not. Failing to repay a mortgage with negative equity may leave you with limited options for finding a new place to live. In most cases, it may not be possible to refinance a mortgage to purchase another property.
How can sellers reduce the effects of negative equity?
If you have negative equity in your home, there are a few steps you can take to mitigate the effects:
- Wait for the market to strengthen: A market recovery can help bring the value of your home back to where it needs to be.
- Hire an estate agent: A professional estate agent may assess your house and advise you on how to best position your property for sale.
- Shorten the mortgage’s term: Getting a home equity loan or refinancing the mortgage can help you lower the monthly payments and reduce negative equity.
How long does it take to recover negative equity?
Negative equity affects homeowners in different ways, with some seeing it disappear in a matter of months and others experiencing it for years. Factors that influence the time it takes to recover include:
- The total amount of negative equity incurred: An enormous initial amount of negative equity may take over five years to recover.
- The duration of negative equity: If the value of your home recovers after a year but then falls again, you may experience it again.
- The average home price in the market: A strong estate market with rising values may help you recover negative equity faster.
- The mortgage amount and the interest rate: Long-term low mortgage rates and monthly payments that don’t increase can help you recover negative equity faster.