Since the start of the credit crisis the term negative equity has been bandied around by the media relentlessly, striking fear into the hearts of homeowners without explaining what this looming threat really means.
So, to help you understand exactly what negative equity is and whether it's something you need to be concerned about, we explain all you need to know about negative equity.
What is negative equity?
Negative equity is the term used to describe your financial situation when the current value of your home is less than the amount you have outstanding on your mortgage.
It's easiest to explain this with an example :
Say, for instance, John bought his house for £250,000 at the top of the market, funding the purchase with a 100% interest-only mortgage.
Now imagine that house prices where John lives have dropped by 20% since he became a homeowner. This would mean that his house is now worth £50,000 less than when he originally bought it.
As the value of John's house is now £200,000 but his mortgage is still £250,000, he is said to be in negative equity as he owes the bank more than he would get for the sale of his property.
Who does it affect?
Firstly, suffice to say that negative equity is only a problem for homeowners, so if you're currently living in rented accommodation this isn't something that you need to be concerned about.
Secondly, if you own your home outright and have no outstanding mortgage on your property this isn't an issue that will affect you either.
If you have bought your house with a large deposit or have built up equity in your property over time then, again, you are likely to remain unaffected unless house prices take a more substantial dive.
However, if you bought your house at the top of the market with a high loan-to-value (LTV) mortgage - such as the 90% - 125% LTV mortgage products previously available - it's likely that you will be affected. This is because the value of your home may now be less than the amount you originally borrowed.
How can I find out if I'm in negative equity?
To find out whether you are in negative equity you will need to find out the current value of your home and compare this to the amount you have outstanding on your mortgage.
Your outstanding balance: You should be able to find out how much you still owe on your mortgage by looking at your most recent mortgage statement. Alternatively, you could simply contact your lender directly and ask them for a balance update.
Your property's value: You have a number of options when it comes to finding out your property's value and which is most appropriate will depend on how accurate you need the estimate to be. Your options include approaching a couple of local estate agents for a valuation, making use of one of several online valuation services currently available or simply look at how much similar properties in your area have sold for.
Once you have both of the aforementioned figures, you simply need to compare the two. If your outstanding mortgage is more than the current value of your home then unfortunately you are in negative equity.
Should I be worried?
Even if you find out that you are in negative equity it doesn't mean that you need to panic. A common misconception is that your house will be automatically repossessed if you've dropped into negative equity but this simply isn't the case.
In fact, as long as you aren't looking to sell in the near future and can still afford to meet your mortgage payments, simply being in negative equity is unlikely to cause you any immediate problems.
What should I do?
Exactly how you should fend off the threat of negative equity depends on both your finances and current circumstances. We explain your options if :
You're in negative equity but can afford your repayments?
The general advice here is to sit tight and ride out the property downturn. Historically data suggests that house prices fluctuate over time and, as such, they are expected to start rising again in the future, although whether this is in a year or 5 will remain to be seen.
In the meantime, providing you're financially secure, now would be a good time to start building up some equity in your property as this will help to buffer you against further price declines. You will of course need to check your mortgage terms and conditions carefully before you make any overpayments but providing you are able to do so without incurring any extra costs, this can be one option to consider.
You're in negative equity and need to sell?
If you need to sell your home you'll be responsible for making up the shortfall between the outstanding owed your mortgage and the amount you make from the sale.
It's important to be aware that your lender will need to give their express permission for you to arrange the sale if the likely return is less than your outstanding mortgage.
If you are unable to continue living in your property then letting out your house may be an option worth considering, however it is vital that you run this past your lender before arranging anything.
You're in negative equity and your mortgage deal is coming to an end?
If you're in negative equity it's going to be very difficult to arrange a new mortgage once your current deal comes to an end. For this reason it can be a good idea to talk to your existing provider to try and re-negotiate a new deal.
If you're unable to do this then it's likely that you'll simply be moved onto your lender's standard variable rate (SVR) once your current deal ends. How this will affect your finances will depend on whether the SVR is higher or lower than the rate of interest you're currently tied to as part of your deal.
If the rate is lower than what you're currently paying, then it's likely that your repayments will decrease too. However, it's important to realise that they could rise at any time so you'll need to be prepared for this eventuality. If you have finances available this could be a good opportunity to pay extra on your mortgage so that you begin to build equity in your home.
If, on the other hand, the rate is higher than what you're currently paying, then your repayments are likely to rise. It's a good idea to prepare for this by saving as much as you can in the months leading up to the end of your mortgage deal as this will help you to cope with the 'payment shock'. However, if your mortgage payments become really unaffordable then you will need to speak to your lender about your options.
You're in negative equity and can't afford the repayments?
If you're struggling to meet your mortgage repayments then it's important to speak to your lender right away. They may be willing to look at solutions that will make your mortgage more affordable.
You should still keep on paying whatever you can in the meantime to show that you're committed to your mortgage repayments and contact an independent advice charity such as the citizens advice bureau for guidance.
The government have also recently introduced a number of schemes for struggling homeowners so this may be an option for you to consider.
You can find further information about the government support available on the Direct.gov website.