Escape the negative equity trap
Around 900,000 homeowners are now in negative equity as a result of falling house prices, with some people owing up to £37,000 more than their home is worth.
Negative equity is when the mortgage outstanding on a property is more than its market value. Falling house prices have pushed thousands of homeowners into negative equity, with first-time buyers and people who borrowed a high proportion of their property’s value particularly affected.
However, the Council of Mortgage Lenders (CML), which has produced the figure, says that unlike the housing market crash in the 1990s – which predominantly hit younger borrowers – the current downturn is causing homeowners from across the board to fall into negative equity.
And with house prices set to fall further, up to six million homeowners could end up in negative equity by the time the housing downturn is over. A report leaked from financial forecaster Numis Securities recently warned that the housing market bubble could eventually see property value slump by a total of 76% from their peak in 2007.
With average prices already down 21%, that leaves a further fall of 55% on the cards if the over-correction in prices matches that seen in the 1990s, the report warns.
If correct, such significant house price falls could leave six million people with properties worth less than their mortgage debt – known as negative equity. It is estimated that around four million homeowners are already in, or close to, this predicament, with research group GfK NOP warning that young people who took out mortgages at the peak of the market are most at risk.
The forecast is extreme – previously even bearish commentators, such as Capital Economics, have predicted prices will eventually fall 35% below their October 2007 peak.
Nationwide's house price index for March showed house prices fell by 4.2% in the first three months of the year, with the average value of a property now at £149,709. Nationwide says that, on an annual basis, house prices at the end of March were 16.5% lower than the same month last year. However, during the month of March, prices increased by 0.9% and house purchase activity reached its highest level since May 2008.
On a regional scale, the picture is more depressing. Some towns such as Blackpool have seen falls of up to 28% in the past six months alone, while values in nearby Accrington are down by 22%. Even upmarket towns such as Windsor, Lewes in East Sussex and Hertford have suffered, with prices falling by 21%, 22% and 26.5% respectively.
Simon Rubinsohn, chief economist at the Royal Institutation of Chartered Surveyors, says that while falling values have attracted more interest from potential buyers, the threat of unemployment along with a lack of available mortgage credit continues to leave the housing market stagnant.
Restricted mortgage lending continues to fuel price falls. There are some signs of the green shoots of recovery; mortgage lending has increased slightly and there are reports of more interest from buyers. However, experts say this will not be enough to prevent house prices from falling further - thus pushing more people into negative equity.
What can you do?
The important thing to remember is that, unless you need to sell or are coming up for remortgage, house price falls are on paper only.
Daniel Lee, chief executive of property website Globrix, says homeowners shouldn’t panic: “For many this will simply be a paper loss, so if possible they just need to sit tight. Sellers also need to remember that if their property has fallen in value by 20%, the property they’re looking to buy will almost certainly have fallen in value as well, so the figure shouldn’t be looked at in isolation.”
However, for those facing the prospect of negative equity, the situation is likely to be causing concern – especially if your current deal is coming up for remortgage.
While mortgage rates are looking attractive at the moment, largely as a result of the Bank of England bringing down the base rate to an all-time low of just 0.5%, unless you have built up a decent equity stake in your home you are unlikely to be offered a new deal.
Best-buy mortgage rates are nearly all for people with at least 40% deposit or equity stake. While there are deals for people who need to borrow between 75% and 90% of their property’s value, these are a lot more expensive.
Ray Boulger, senior technical manager at John Charcol, says that 75% loan-to-value mortgages (i.e. 25% equity) is the key threshold. “People only seeking mortgages of 65% to 70% will have a wider choice,” he explains. “But people close to the threshold may struggle as house price falls could push them into higher loan-to-value requirements.”
If you are coming up for remortgage, then it’s vital to think about how you can beat falling house prices and increase the amount of equity you actually hold in your home.
If you are on an interest-only mortgage (i.e only paying off the interest rather than the loan capital) then your monthly payments are being used to clear the interest on the loan, not the mortgage itself. This means that the mortgage itself never gets any smaller and you won’t be building up any equity in your home.
If you can afford to, it is well worth switching to a capital repayment mortgage so you can start eating into your mortgage debt. Contact your lender to see how making this move will affect your repayments and then do a budget to ensure you can afford it.
There are a few points to bear in mind if you decide to switch your repayment plan. First of all, you may be charged a fee of up to £100 for switching. Secondly, you may not be able to switch back to interest-only down the line and you’ll certainly find it very difficult to release any equity from your home in the near future, especially if you haven’t built up much equity.
Finally, it is always worth having an emergency savings fund or buffer that you can call on if you need money so don’t overstretch yourself.
Another way to increase your stake in your home is to make overpayments. The majority of lenders allow overpayments, typically up to 10% per year either in a lump sum or on a monthly basis.
Others, like Northern Rock, allow you to make unlimited overpayments without penalty – although you will still be charged an early repayment fee if you pay off all your mortgage early.
Check with your lender to see how much you are allowed to overpay a year. Don’t forget that if you exceed your overpayment allowance you will be hit with an early repayment charge, typically around 2% to 3% of your outstanding balance.
If you have a tracker mortgage then you will have seen your monthly payments decrease over the past six months in-line with Bank of England base rate cuts. Your lender will have automatically reduced the amount of money you have to pay it each month – but rather than let this money languish in your current account or get frittered away, it is worth considering putting it back into your mortgage.
This will count as an overpayment so check with your lender to see how much you are allowed to increase your monthly payments by.
Also, if you have more expensive debt elsewhere (for example, on a credit card or personal loan) then it might be more worthwhile using the savings from your tracker to pay this off first, as the interest rate is likely to be higher. Some historical forms of credit might not allow you to repay the debt early, however, so bear this in mind before taking action.
If you do find yourself in negative equity, don’t panic. While you won’t be able to remortgage and get a new fixed or tracker discount deal, your current lender is not about to kick you out in the street. Instead, you’ll find yourself moved onto their standard variable rate (SVR).
Your lender will contact you to let you know what your SVR is.
A word of warning
While many people with low or negative equity are being forced to sit on SVRs because they can’t remortgage elsewhere, mortgage brokers also report a large number of people are opting to stay on SVRs in anticipation that new mortgage deals will soon become cheaper.
Matt Andrews, managing director of Moneyworkout, says 12% of its enquiries in February came from people planning to stay on their SVR even thought they had enough equity to remortgage.
However, while their SVR may be cheaper in the short-term, there are concerns that falling house prices could reduce their opportunities to remortgage.
Andrews says that customers sitting on SVRs have an average equity stake of 24% - so while they should still be able to find a new deal, they are sitting on the cusp of the market.
“With SVRs lower than most new remortgage products it is extremely tempting to stay where you are and enjoy the low rates, comfortable in the thought that you will fix when rates start to increase,” says Andrews. “You must also think about your property value – as house prices fall, the value of your property in relation to your borrowing increases.”
What this means is that as your property value falls, the equity stake you have in it also decreases. The smaller the equity stake you hold, the higher rate you are likely to pay on a mortgage as you move up the LTV bands.
David Hollingworth, mortgage expert at London & Country, is also concerned about the number of people taking a short-sighted approach to their mortgage, by sitting on their SVR. “People are hoping to see cheaper mortgage rates down the line, but personally I don’t think deals will get much cheaper,” he says.
“Even if mortgage rates were to drop a few percentage points, this saving is nothing when compared to the additional price you’ll pay if you fall into a higher LTV band.”
If you are in a position to get a new mortgage deal, then the advice from both Andrews and Hollingworth is to take action now by locking into a new fixed or tracker-rate deal.
“You may have a fantastic SVR now, but look at your LTV, look at property prices in your area and how they are moving - if your mortgage may cross the 80% boundary with the fall in property prices, you may want to consider fixing now, before its too late,” Andrews explains.
A “traditional” mortgage, where the monthly repayments entail of repaying the capital amount borrowed as well as the accrued interest, so that during the loan period the capital debt is gradually paid off so by the end of the term the mortgage has been fully repaid. One advantage of a repayment mortgage is that it removes the risk of having a parallel investment (such as an endowment policy or pension), the performance of which is dependent on the stockmarket, such as with an interest-only mortgage.
Every mortgage lender has a standard variable rate of interest, or SVR, on which it bases all its mortgage deals, including fixed and discounted rate and tracker mortgages. When special deals come to an end, the terms of the deal usually state that the borrower has to pay the lender’s SVR for a period of time or pay redemption penalties. The lender’s SVR is, in turn, based on the Bank of England’s base lending rate decided by the Bank’s Monetary Policy Committee (MPC). Every time the MPC raises its rate, mortgage lenders generally increase their SVR by the same amount but when the MPC lowers its rate, lenders are often slow to pass this on or don’t pass on the full cut to borrowers.
With a tracker mortgage, the interest you pay is an agreed percentage above the Bank of England’s base rate. As the base rate rises and falls, your tracker will track these changes, and so rise and fall accordingly. If your tracker mortgage is Bank of England base rate +1% and the base rate is 5.75%, you will be paying 6.75%. Tracker rates are lower than lender’s standard variable rate (SVR) and as they are simple products for lenders to design, they usually come with lower fees than other mortgage schemes.
The circumstances in which a property is worth less than the outstanding mortgage debt secured on it. Although it traps householders in their properties, the Council of Mortgage Lenders (CML) says there is no causal link between negative equity and mortgage repayment problems. At the depth of the last housing market recession in 1993, the CML estimated 1.5 million UK households had negative equity but most homeowners sat tight, continued to pay their mortgages and eventually recovered their equity position.
A loan in which the borrower pays only the interest on the sum borrowed for the life of the mortgage but, at the end of the mortgage term, they still owe what they originally borrowed as this remains unchanged. The advantage of an interest-only mortgage is the monthly repayment is considerably lower than for a comparable repayment mortgage. Lenders generally insist the borrower also invests in an endowment, ISA or pension savings policy that, on maturity, is intended to pay off the capital loan.
Used by the holder to buy goods and services, credit cards also have a monthly or annual spending limit, which may be raised or lowered depending on the creditworthiness of the cardholder. But unlike charge cards, borrowers aren’t forced to pay the balance off in full every month and, as long as they make a stated minimum payment, can carry a balance from one month to the next, generating compound interest. As the issuing company is effectively giving you a short-term loan, most credit cards have variable and relatively high interest rates. Allowing the interest to compound for too long may result in dire financial straits.
An account opened with a clearing bank (few building societies offer current accounts) that provides the ability to draw cash (usually via a debit card) or cheques from the account. Some pay fairly minimal rates of interest if the account is in credit. Most current accounts insist your monthly income (salary or pension) is paid directly in each month and they offer a number of optional services – such as overdrafts and charge cards – which are negotiable but will incur fees.
Also referred to as the bank rate or the minimum lending rate, the Bank of England base rate is the lowest rate the Bank uses to discount bills of exchange. This affects consumers as it is used by mainstream lenders and banks as the basis for calculating interest rates on mortgages, loans and savings.