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The Dangers of Negative Equity

Be Positive

The great thing about buying a property is that it’s a guaranteed investment, prices just keep going up, right? Wrong. We look at what happens when the bubble bursts and prices drop.

Supply and Demand

Usually property is a terrific investment opportunity. In these small islands we call the British Isles space is at a premium. We are very over crowded and geographically jobs are not evenly spread. This makes demand for housing especially concentrated in the South East, where unfortunately it appears most of the work is.

This demand means there are nearly always more people looking for property than there are people selling. And basically that is what continues to stoke land and property prices ever upwards.

Equity example

Let’s say you bought a house that was on the market for £150,000. You take out a mortgage for £130,000 then sit back and wait for its value to increase. Property prices have slowed in recent years, so let’s say that after a year your house has increased in value by 3%, you house is now worth £154,500. Your mortgage was a repayment mortgage and you’ve paid off £800 in that first year so the equity in you house is the difference between what you owe and what its worth, that is, £25,300.

The idea is that every year you will be able to continually grow that equity as you reduce the mortgage and the value of the house naturally increases. In the past annual price increases were as high as 20%, so on a £150,000 property people were seeing a massive £30,000 increase in equity on the value alone.

That is why the property market was seen as such a good investment opportunity in the nineteen eighties. It was just one of the ways many people could get very rich very quickly.

But the bubble has a tendency to burst every now and then and when it does, there comes the very real danger of negative equity.

Negative, Captain

Negative equity is when the house is no longer worth more than the mortgage and it can have a nasty sting in the tail if you also become unable to pay the mortgage.

The last time the housing bubble burst was in the recession of the early nineties. A recession is also a time when a lot of people lose their jobs and so their ability to pay mortgages becomes strained.

Sell, sell, sell

You may think the answer is to just sell up, but if your property has plummeted in value to less than the mortgage why would you want to sell?

Let’s say you had that £130,000 mortgage, your house was worth £150,000, it’s now dropped almost overnight to £100,000, which means you have £30,000 negative equity. If you can’t afford the repayments because you lost your job, then putting the house on the market will mean that you will still owe the mortgage company £30,000 after you sell the house. Not a nice situation to be in.

Let them repossess the house. Again, not a great idea as they will repossess the house, sell it for whatever they can get for it on a quick sale to realise some of their debt, let’s say they get £80,00 and guess what, they can still come after you for the balance of the mortgage loan you had with them. Now you’ve lost your house and you owe the lender £50,000: it’s even worse than before.

Nightmare on Recession Street

This was the situation that many people found themselves in during the nineties. Negative Equity can be a nightmare. The best thing to do is to find a way to be able to pay the mortgage, no matter what. Pay it back, arrange to pay back less, arrange to clock up an arrears for as long as possible, anything that enables you to last out until the property market starts to pick up again. Then, once you have positive equity again, if you have to, you can sell the property to pay back your debt and start all over again.

It’s the threat of negative equity that drives lenders not to be generous with distributing 100% mortgages. And it’s a threat that is as alive today as it has ever been.

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