Negative equity is when your property is worth less than the mortgage secured on it.
In a market where house prices are falling, homeowners with high loan-to-value mortgages are more at risk of negative equity, and this can affect their ability to sell.
It can be a scary place to be, but it’s important to understand exactly what negative equity means for you and this guide can help.
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How do you calculate equity in a home?
Your initial equity in your home is earned through the deposit you put down to buy it.
For example, if you bought a property for £200,000 and put down a 10% deposit, you would have £20,000 in equity.
Your equity can increase over time as you pay back more of your mortgage and if your property grows in value.
To calculate the equity in your home, you should first have it valued.
Once you have an accurate valuation, take that figure, and subtract the amount of money you have outstanding on your mortgage.
For example, if your property is valued at £300,000 and you have £245,000 outstanding on your mortgage, you would have £55,000 in equity.
How do I work out if I’m in negative equity?
To work out if you’re in negative equity, take the current value of your property
and subtract the amount you have outstanding on your mortgage.
If the resulting figure is below zero, then you are in negative equity.
As an example, if you purchased your home for £300,000 with a 90% mortgage of £270,000, you would have £30,000 in equity at the time of purchase.
You pay off £8,000 off your mortgage in your first year of ownership, bringing your mortgage down to £262,000.
But if a fall in prices saw your home’s value drop to £240,000, you would have £22,000 of negative equity.
Am I at risk of negative equity?
You’re most at risk of negative equity if you have very little equity in your home and house prices fall.
If property prices do fall, you’ll be most at risk of negative equity if:
- You’ve only just purchased your home
- You bought your home with a high loan-to-value mortgage, such as 90% or 95%
- You paid for your home when its value was at its peak, or you paid a premium
- Your mortgage is an interest-only loan
Don’t panic – negative equity isn’t the end of the world. If you’re not desperate to move, wait it out, keep making your mortgage repayments and wait for your equity to build.
What happens if you sell a house in negative equity?
If you’re in negative equity, the value of your home is less than your outstanding mortgage, so selling can be very difficult.
If you did decide to sell, the proceeds would only pay back a portion of your mortgage and you would be responsible for the remaining amount.
Your lender may also be able to stop you selling during the conveyancing process unless you have the means to pay back the balance of your mortgage.
If you really do have to sell and you’re in negative equity, you should speak to your mortgage lender in the first instance.
You could also consider:
- Paying down more of your mortgage before you sell, if your lender allows this, moving you into positive equity
- Using any savings you have to cover the shortfall between your sale price and outstanding mortgage
- Spending money on improvements that could boost the value of your home and put you back into positive equity
If you need to move, but you don’t necessarily need to sell your home, you could consider renting it out to avoid problems selling when in negative equity.
The first step if you do want to rent out your home is to speak to your mortgage lender, and you’ll need to factor in:
- Whether you’re able to switch to a buy-to-let mortgage, which could come with a higher interest rate
- Whether switching could see you incur lender charges
- Whether the property is suitable to rent out meets rental compliance standards
- Whether you would manage the property or if you’d use a letting agent
Can I remortgage if I’m in negative equity?
When your mortgage deal expires, you would normally consider remortgaging on to a new deal.
However, if you’re in negative equity, your lender may now allow this, meaning you’ll be left on their Standard Variable Rate (SVR) with potentially higher repayments.
If your deal is coming to an end and you’re in negative equity, speak to your lender to find out your options.
How can I get rid of negative equity on my mortgage?
If you find yourself in negative equity, the best step you can take is to stay in your home and keep making your mortgage payments.
Over time, you’ll pay down more and more of your mortgage which can help increase the equity you have in your home.
If your mortgage lender allows you to overpay, you could also consider doing this as a faster way to reduce any negative equity.
For advice on how to change your mortgage, speak to a broker.
How to avoid negative equity
Avoiding negativity starts when you first purchase your home, and you should:
1. Put down as big a deposit as you can
If you have the savings, putting a bigger deposit down can increase your equity in the property and reduce your risk of falling into negative equity if house prices do fall.
For example, if you purchased a £300,000 home with a £30,000 (10%) deposit, a large drop in property prices of above 10% would put you in negative equity.
If you were able to buy the same home with a £50,000 (16%) deposit, however, a 10% fall in house prices wouldn’t put you in negative equity.
2. Buy at below market value
If you’re able to buy your property for less than its market value, this can help wipe out the prospect of negative equity if prices do fall.
If the seller is looking for a quick sale, they may be open to an offer and the more you can save at the beginning, the better off you’ll be further into your ownership.
What is a negative equity mortgage?
Some lenders offer special mortgages for those in negative equity but who need to move home.
This sees the lender transfer the shortfall between your existing mortgage and sale price to a new mortgage on the property you want to move to.
A lender’s decision on a negative equity mortgage will very much come down to individual circumstances, but these mortgages can include:
- Potential increases in fees or charges
- Higher mortgage interest rates
- Early repayment charges
While negative equity mortgages can help, the interest rates tend to be higher so it’s always best to wait it out if you can.
Further reading…
- Want a stress-free move? Read these nine tips
- Key advice for buying and selling a home
- The best (and worst) times to buy revealed
Still have questions? Contact your local CJ Hole branch today.
