Negative equity is a term that is dreaded by every homeowner. So, what does it mean and how you can escape it?
What is Negative equity?
Negative equity is a situation when the mortgage amount on the property is more than the current market value of a property. For example – An outstanding mortgage on a property is £200,000 and the value of the home is only £180,000, which means that there is £20,000 worth of negative equity.
Apart from this, any second mortgages and secured loans may also contribute to negative equity. So, for example, a £6,000 loan over and above the £200,000 mortgage would mean £26,000 worth of negative equity where the property worth is £180,000.
Why does negative equity come into picture?
There are a number of reasons for it such as;
- Falling property prices are the most common cause of negative equity.
- High loan to value borrowing, which means bigger the loan taken to buy a property, higher the chance of getting sucked into negative equity in case the house prices fall.
- Interest-only mortgage, which means the property buyer is paying only the interest portion of the loan every month and not the capital.
- Additional secured borrowing also adds-up to the negative equity.
- Missing mortgage repayments may also affect the negative equity if combined with any of the above scenarios.
How to escape negative equity?
The best option to escape negative equity would be to stay in the current home and slowly pay away the mortgage and wait for the property prices to rise. But there are other options also;
- Sell the property and repay shortfall – Though it may not be an ideal solution, however, some mortgage lenders allow selling of property in negative equity so that the shortfall can be paid off over a period of time.
- Paying down the mortgage – Mortgage rates are typically higher than the savings rate, so reducing the mortgage amount with any money you have is a good option.
- Borrow the shortfall – If the difference between the value of the property and the outstanding mortgage isn’t very high, then an option available to you would be to borrow the amount from friends, family or take an unsecured loan to pay off. However, an unsecured loan may add up to the total debts if you can’t pay it off in a timely manner.
- Rent out the property – In case the property is located in an area where it is easy to rent, then rental income might cover the mortgage amount or even provide a surplus. However, if you decide to rent the property it has to be done in consultation with the mortgage lender.
The bottom line is if you have negative equity, much will depend on how accommodating the mortgage lender is willing to be.