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Negative equity - why is it a problem?

Negative equity occurs when the value of an asset falls below the outstanding debt left to pay on that asset. Term is most commonly used in connection with property prices and describes a situation where the market value of a house is less than the existing mortgage debt.

Thus if a home-buyer purchases a property worth £220,000 using a 95% mortgage – with the lender providing a loan worth £209,000 and – two years later – the value of the house has dipped to just £185,000 with £205,000 left unpaid on the mortgage, then the property owner is in a situation of negative equity to the tune of £20,000.

Other things being the same this is not a fundamental problem because the homebuyer may have already decided to remain in their house for the foreseeable future and can simply wait for property prices to rebound at a later stage of the economic cycle.

But if those people concerned are forced to sell their property – perhaps because of unemployment or a change of family circumstances, the negative equity problem really starts to bite. Even selling the house will leave them with a substantial chunk of unpaid mortgage debt to finance perhaps requiring a large run-down of savings or another loan.

Thus negative equity can impede the geographical mobility of labour and it also increases the risks of families where the main bread-winner loses their job and suffers a fall in income ending up in poverty.

Negative equity also leads to a psychological effect on consumer confidence and our willingness to borrow to finance major items of spending.  It is clear that the boom in mortgage equity withdrawal – where homeowners can remortgage and unlock some of the equity in their property to fund spending – is now at an end. The latest Bank of England figures confirm this – debt repayment is fast becoming a priority for millions of indebted Britons.

In the depths of the last UK housing recession in the early-mid 1990s, over 1.3 million households were estimated to be in negative equity. The risks are highest for those who bought at or near the top of the market and who perhaps over-extended themselves in buying a home with a mortgage close to 100% of the purchase price.

The media is full of stories at the moment of the steep increase in those affected by negative equity. The Sunday Times ran a story at the weekend citing a report that forecast that two million households will be in the negative equity trap by the end of next year.  The credit rating agency Standard and Poor’s has estimated that over 250,000 households have moved in this situation over the last four months. Many people who have been lured into taking out consolidation loans (secured on property) to pay off credit card debts are also exposed to the property slump.

Mortgage lenders are under the microscope for increasing the rate of repossessions from households who have fallen into arrears on their loans.

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