There are two forms of negative equity. Both unpleasant, but one worse than the other due to the limitations it puts on those who suffer it.
This can be described as cash negative equity and mortgage negative equity.
Cash Negative Equity
This is where a property has been purchased without the use of borrowing and the property value for whatever reason has fallen below the amount paid.
This could be due to market conditions, damage to the property that is not covered by insurance or just the fact that the price paid was too high at the outset.
Mortgage Negative Equity
Obviously, the worse of the two, this is where a property has been bought with finance and now the value of the property does not even cover the amount of the loan.
This usually means that the owner is stuck with a mortgage in excess of the value of the property and factor in the cost of buying and selling and all in all it is a pretty sorry state of affairs.
Surprisingly, sometimes negative equity really does not matter. After all, a loss is only made when you actually sell the house, but as is often the case, negative equity has a severe impact on the lives of those involved.
Example Buyer In Negative Equity
Imagine a first time buyer who bought a one-bedroom flat a few years ago for say £100,000.
They would have probably taken an £85,000 mortgage and put in £15,000 of their own money plus a few thousand pounds for buying fees, perhaps new carpets, etc.
If that property has now dropped to say £80,000, not only have they lost their costs and £15,000 deposit, but also they are unable to move.
Unless they can demonstrate to the mortgage company that they have the additional £5,000 shortfall to clear the mortgage when the property sells. Far from ideal.
Of course, if the property does not need to be sold, this really is not too much of a problem other than on paper as the loss is only made when the property is sold.
However, this fictional first time buyer is now expecting a baby and a one-bedroom flat is not going to be sufficient.
What To Do About Negative Equity?
There are a number of solutions to this problem. . .
I am afraid that none of them get to the root of the problem which is the fact that the property is now worth less than it was when bought.
The sad fact is that this is just something that happens to property from time to time. Losses are made in bad times and in the good times prices go up and whether an individual is successful or not, depends an awful lot on luck and timing.
Anyway, back to the solutions. . .In order to get moved, a borrower can take out a loan from (for example family) the bank or indeed the actual mortgage lender themselves to top up the shortfall and then apply for a whole new mortgage on another property.
A borrower should speak to the bank or lender to find out what solutions may be available.
Renting Your Property Out?
At the start of writing, rents are at an all-time high and mortgage rates at an all-time low.
So, there are many people now renting houses that are either difficult to sell or in negative equity to avoid taking the loss.
With such favorable rates at the moment, many people are actually making a profit on such rentals and then going off and either taking another mortgage to buy elsewhere for themselves or otherwise they are becoming tenants.
Our fictional first time buyer could do this in order to move to a two-bedroom property when the baby comes along, but there are a couple of important things she would need to know.
- When you rent the property out, you should inform the mortgage lender that this is what you are doing and they may look to increase the interest rate when you vary the mortgage in this way.
- As additional income will be made, this will need to be declared on a tax return. So, careful records will need to be kept on income and expenditure and then tax will be due on any profit.
- There is an inherent danger in renting a property and relying on the rent to pay rent for yourself elsewhere. You have very little control over whether your tenant will actually pay on time or indeed pay at all. If you are unlucky and choose a bad tenant, not only may the case be that you do not get rent, but you may also have legal costs to get the property back.
The landlord of the property that you are now living in may well be sympathetic to the situation, but at the end of the day it is really not their concern and they will look to you to pay rent in full and on time, come what may.
Is The Safest Solution To Simply Sit Tight?
If you do not have to move and you are quite happy in your home, doing nothing is perhaps a good option.
As I have previously said, the market peaks and dips in very regular patterns and whilst the current dip is particularly severe, it does not mean that there will not be another rise in the years that follow.
After all, the UK is a limited piece of land with a growing population and therefore property will over time become more and more scarce and therefore valuable.