House prices fell by almost 3% in January according to the Halifax house price index, while over the last three months they have dropped by around 0.8%. With Brexit almost upon us, and the potential difficulties that will bring, it can be a nervy time for homeowners.
One big concern, particularly for those who bought their homes with only a small deposit, is negative equity. But what is it and why does it matter?
What is negative equity?
In simple terms, negative equity is when the size of your outstanding mortgage loan is larger than the value of your property.
It can happen when house prices drop significantly. Let’s say you bought a property for £200,000, with a £20,000 deposit. That £20,000 is your equity in the property - it’s the portion that you own outright. You then have a £180,000 mortgage that you need to pay off.
A year later, house prices have fallen by 20%. As a result, your property is now only worth £160,000, but your outstanding mortgage will still be above £175,000, leaving you in negative equity.
Clearly, people who buy a property with only a small deposit are going to be more at risk of falling into negative equity, as it only takes a relatively small drop in house prices to leave them owing more than the house is worth.
Does negative equity matter?
The first thing to emphasise is that being in negative equity does not mean you will lose your house. Your mortgage lender just wants you to keep up with your repayments in full each month.
However, being in negative equity can cause problems if you want to remortgage or move to a new property.
If you bought your property with a fixed rate mortgage, then when you come to the end of the initial fixed rate period, you will want to remortgage to a new deal. Otherwise you will move onto your lender’s standard variable rate, which is invariably more expensive, as well as being subject to potential increases when the Bank of England decides to raise the base rate.
However, in order to do this you will need to have some equity in the property, generally at least 5%. As such, remortgaging is unlikely to be possible, meaning you are lumbered with those higher repayments until you build up sufficient equity.
It’s a similar story if you want to move house. If the amount that you can get by selling the property is not enough to clear the mortgage, then you will need to find the rest of that money from somewhere. You’ll also need to get enough money together for a deposit on a new property.
How to avoid falling into negative equity
If you’re in negative equity, you really have two options. You either need to increase the value of your property, or you need to reduce the size of your outstanding mortgage.
The latter is more straightforward - most mortgages allow you to overpay by up to 10% of the outstanding mortgage balance each year, without then hitting you with early repayment charges. By paying more than your set mortgage repayment, you will reduce the size of the mortgage that much quicker. It will also save you thousands of pounds in interest charges.
Overpaying can also work as a good defence against the potential of falling into negative equity in the future.
If you want to take the other route, and increase the value of your home, then this is likely to involve more significant upfront spending. There are all sorts of measures that might increase its value, for example adding an extension which will make the property larger, or investing in a more modern kitchen or bathroom.
None of these are guaranteed to increase the value of your property though. It may be worth a chat with a local estate agent to get their insights into what might work for you.