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By Ben Kennish

You Might Have Heard the Term, but What is Negative Equity?

You Might Have Heard the Term, but What is Negative Equity?

Negative equity is a term that’s used commonly in reference to finance, particularly in the property industry. It’s a phrase that’s thrown around, more often than not without being properly understood.

But what is negative equity? Is it important, and can it really affect home owners all that much?

Today, we’re going to be taking a look at what it means to have negative equity, how it can be tackled, and whether or not it’s likely to affect you.

First Things First, What Does it Mean? What is Negative Equity?

One of our most commonly asked questions, is what negative equity actually means.

Very simply, negative equity is when the market value of a property falls below the amount that’s outstanding on the mortgage you secured on the said property.

This can be caused by factors such as borrowing too much, having too high a mortgage and even the property market changing. It is fluid, after all.

Example One of Negative Equity

Before going any further, we’re going to give you a couple of examples of exactly what negative equity is. Sometimes it’s easier to understand with the numbers in front of you:

  • To start with, we’re going to explain what positive equity is.
  • So, for starters as an example, let’s say that you’ve bought a property for the sum of £160,000.
  • On this same property, the mortgage you secured and purchased it on was £130,000.
  • In this particular scenario, you would be in positive equity of £30,000.
  • That’s an example of positive equity.
  • Now, let’s take a look at how negative equity comes about.
  • Say that you’re in the same situation, with the same costs and numbers, but the market value of the same property has now fallen to £120,000.
  • In this scenario, you would find yourself in negative equity to the sum of £10,000.

Example Two of Negative Equity

We have one more case to share with you that exemplifies how negative equity can come around:

  • The cause of this example tends to be when a buyer borrows a mortgage that is greater than the actual value of the house.
  • This is usually the fault of the mortgage lender; in that they have allowed the buyer to borrow more than the home is worth in the beginning by not adhering to the proper procedure. This could be due to the estate agent overpricing the property, and the buyer naively paying the price. It happens more often than you might think.
  • In the past, however, there were deals available on mortgages where you could get anywhere up to 125% of the market value of the house. It’s crazy, looking back.
  • So, if this happened to be the case now, and you bought a home for £150,000, the loan would therefore be £187,500.
  • If you wanted to figure this out in reference your own mortgage, the sum is just 1.25 times the market value of the property in question.
  • In this case, you’d be in negative equity from the moment you moved into the property. The sum of this particular negative equity would be £37,500.
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Can Help to Buy Schemes Affect Negative Equity for Buyers?

One of our most commonly asked questions, is whether or not buying property with the assistance of the government’s “help to buy” schemes can be a negative equity trap:

  • In case you weren’t already aware, in the UK, the government have a scheme in place to help people become home owners, and to get their foot on the property ladder. This is referred to as the “help to buy” scheme, and was created for the use of first time buyers.
  • In this particular scheme, the government will lend you 20% of the cost of the purchase price of your property.
  • However, in London, because the cost of living is more expensive and therefore so is buying property, they’ll lend you 40% of the purchase price. This is, of course, relative to the rest of the economy, after all. It doesn’t put Londoners at any advantage.
  • So, in exchange for lending you this percentage, the government take a share in the property, which is unsurprising. You don’t get anything for nothing, these days!
  • In regards to the help to buy scheme, the good news is that the first five years of the loan is interest free.
  • However, before you partake in a help to buy scheme, there are certain requirements that you must adhere to.
  • The first of these is that you must put down a deposit of at least 5%.
  • Now, remember that this isn’t the deposit in its entirety. Let’s take out example outside of London.
  • So, you’ve got your 5% deposit. You now have to combine this with the 20% deposit in your “help to buy”.
  • Overall, this equates to the deposit being a total of 25% of the asking price.
  • Then, following this, you have to take out a mortgage that stands at the remaining value of the property in question, which is 75%.
  • If you’re based in London, then this is how it’ll look for you.
  • Your deposit of 5% which is combined with the governments addition of 40% equates to a whopping 45% for the overall deposit.
  • This leaves another 55% of the mortgage to be paid by those who are living and buying in London.

But Be Cautious! Smaller Deposits can Be a Trap that Lead to Negative Equity

Particularly for first time buyers, the smaller deposit you can make on property, the easier it’ll be to get your foot on the ladder. But is it really a good idea to put down as small a deposit as possible?

  • Buying with a smaller deposit, so say for example the 5% put forwards in a help to buy scheme, it can be risky.
  • This is because, even if the price of property falls by a small amount, it can quickly erode the small amount of equity you hold on the property.
  • The issue is that a 5% decrease in housing prices, really isn’t an uncommon occurrence.
  • As we type this today, housing prices are falling – and nowhere more so than in the capital, London.

Is Help to Buy Any Different?

But surely if it’s a government scheme, help to buy is a little safer, right?

  • It’s arguable that if you’re in this position with a help to buy scheme, then you’re in a slightly better position.
  • A conventional 95% mortgage would be likely to put you in a far worse position financially, than one acquired through a help to buy scheme.
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An Example Using a Help to Buy Mortgage Scheme

It can be a lot to take in, but we’re going to round off by giving an example of equity in regards to using a help to buy mortgage scheme:

  • The main difference between a conventional mortgage and a help to buy mortgage, is that with help to buy, the government actually own a percentage of the property rather than a set regulatory amount.
  • So, as an example, say your property is valued at £150,00 and then it drops to £125,000, whereas the original help to buy percentage (using outside of London as the example) started at £30,000.
  • The fall of the value of the property now means that the help to buy percentage has dropped to £25,000 rather than the original £30,000.
  • So, if we’re looking at this in percentages, in this particular example the value of the property has fallen by a total of 16.7%.
  • Let’s stick to this example. Originally you would have borrowed a total of 75% of the value of the house.
  • Converting this into financial terms, it means that your mortgage would have stood at the cost of £112,500.
  • On top of this, you’d also have to consider the original cost of the help to buy loan which was £30,000.
  • Adding these together, it becomes clear that the loan, in its total amount, would come to £142,500.
  • We’re going to assume that in this scenario, there has been no significant repayments of the mortgage made so far.
  • The total amount of borrowing will consist of the original mortgage, which was £112,500, to the now revised rate of the help to buy loan, which currently stands at £25,00 instead of £30,000.
  • The total amount of money you would now on the mortgage of the house in question would be £137,500 in its’ entirety.
  • So this would mean that given the house was originally worth £125,000, you’d find yourself in negative equity to the sum of £12,500.
  • We know, it’s a lot of numbers, facts and figures to take in – but it’s quite simple when you get used to it.

So there we have it. That’s our in depth explanation as to what negative equity actually means, and the most common ways in which it occurs.

We hope that we’ve been able to help you to better understand negative equity and its’ causes, by providing you with clear explanations and pertinent examples.

Thanks for reading!

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Ben Kennish Property Solutions
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2 Tallis St,
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EC4Y 0AB

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ben@benkennish.co.uk

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