Negative Equity on a mortgage in the UK

Borrowers are usually confident in their financial security because when they buy a property they become the formal owners of it. This means that no matter what happens,** by selling their property they should come out at zero or even make a profit on it**. If only in the worst-case scenario for the borrower, i.e. the bank foreclosing on the property - once the property is sold, they should no longer owe anything. However, this is not always the case. In this article, we will talk about a phenomenon called Negative Equity and advise on what you can do in such a situation.

What is Negative Equity?

The term Negative Equity is used to describe a situation in which the market value of the property is lower than the outstanding amount of the mortgage. This means that the sale of the property could not fully cover the borrower’s debt. For the bank, such a turn of events is a warning signal that the risk under the respective mortgage agreement has increased. This affects a number of different aspects of the mortgage and the actions that the property owner can take.

In practice,** if you intend to repay the same mortgage until the end, and your financial situation is secure and you pay the instalments on time, Negative Equity does not pose any great threat to you**. You have a specific mortgage balance to repay, and how much your property is worth has no application in this. The problems mainly arise when you want to take some action - get better mortgage terms through remortgage or sell the property. That’s when you may find your hands are tied.

Negative Equity and remortgage

Remortgage is a very popular technique used in the UK to improve the terms of a mortgage. One of the reasons this is achievable is that refinancing is usually done a few years after starting to pay off the current mortgage. During this time, the balance to be repaid decreases, along with theLoan-to-Value ratio. Here, it is important to remember one rule - the lower the LTV ratio, the better the mortgage terms will be.

If the value of the property has fallen significantly, a remortgage may be very difficult or even impossible to realise. Here, too, a lot depends precisely on the LTV ratio - for a new mortgage it should be at least 90% - 95%, but in such a situation the conditions can still be very poor. A remortgage in the case of Negative Equity loses its profitability, because then the LTV can be as high as 100% or more.

Let us use an example to illustrate the whole situation with numbers:

Let’s assume that the price of the property was £300,000 and the mortgage had an LTV of 85%. The amount borrowed from the bank is £255,000. After three years, the borrower has repaid £10,000 of the outstanding balance and wants to do a remortgage. This time the amount he needs to borrow from the bank is £245,000 and the** LTV ratio has reduced to 81%, allowing for even better terms.**

During the 2008 financial crisis, property prices were falling by 15% - 20%. So what if the value of the property had fallen by 15% over those 3 years, or up to £255,000? The outstanding balance on the mortgage is £245,000. This brings the LTV ratio up to 96%. This is the level at which most banks will firmly refuse to lend a mortgage.

Of course, the example shown is very drastic, but in such uncertain times it is useful to know how the economic crisis can affect mortgages.

Sale of property at Negative Equity

If your property is worth less than the capital remaining on your mortgage,** selling the property is strongly discouraged**. Firstly, such an operation requires the bank’s approval - the institution has to check whether you will be able to cover the difference from your savings. If you are unable to do so, there is a fairly small chance that the lender will agree. In some cases, it is possible to pay the amount due in instalments, but this solution is quite rare.

A situation in which you will consider selling your home while your mortgage is ongoing, on top of Negative Equity, is highly unlikely. Even if it happens to you, remember that property prices will fall sooner or later, and selling a property in such a situation is probably the least profitable option.

What situations can cause the value of a property to fall?

Many factors influence theprice level of a property - both external, macroeconomic factors and internal factors such as the condition of the building. Unfortunately, in most cases, we have no control over the price of our property. Such market behaviour either occurs unexpectedly or intensifies over time. Below we will outline some of the possible causes of falling property prices.

Rising interest rates

When the Bank of England raises interest rates, it reflects heavily on the property market. As mortgages start to become more expensive, fewer people choose to take them out. This results in a fall in overall demand for property, leading to lower property prices. Although the interest rate has been falling for the last year, it is good to know that we may be facing an increase again in the future. The bank usually decides to do this in the event of high inflation or anoverheated economy. Price falls in such cases can reach several percent.

Local issues

Changes in a particular location can also affect property prices. This is one factor that can take years to develop, causing prices to fall further and further. For example, an increase in crime, a deterioration in the level of education in schools or environmental problems make a region less attractive to live in. Such changes do not necessarily have to be spread out over time - it is not a rule. Imagine that a major company has just closed down in a particular location. Such a sudden event reduces the attractiveness of the area, as many jobs for potential residents disappear from the market.

Economic crisis

Along with the recession also comes falling property prices. Rising unemployment and financial uncertainty push people away from taking out mortgages and buying homes. Such a phenomenon could be seen, for example, during the 2008 crisis. As mentioned above, property prices fell by up to 20 per cent. Another crisis that comes to mind is the Covid-19 pandemic, which started in 2019. Then, at the very beginning, property prices also fell, but in this case they quickly recovered. This was thanks to the Stamp Duty exemption for buyers and record low interest rates.

Summary

The appearance of Negative Equity during the repayment of a mortgage is an extremely unpleasant situation. However, it is important to remember that, except in extreme cases, property prices do not fall dramatically and every crisis eventually passes. In the long term, housing prices always rise, so the best idea will usually be to wait out the decline and unfortunately hold off on carrying out a refinancing.