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Negative Equity Explained

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Mortgages  Negative Equity  Responsible Lending 

By - Friday 10 September 2010

A recent report from the UK based National Housing Federation claims that buyers who purchased property in 2007, at the height of the property boom, are likely to remain in negative equity until at least 2014.

So, what is negative equity?

The equity of an asset is calculated by subtracting the outstanding balance of the mortgage from the current value of the asset. Negative equity occurs when the value of a financed asset is lower than the money owed on the said asset. A common example refers to property; the value of property is cyclical and consequently varies.

A property that has been purchased at the height of the market using finance, is at a higher risk of falling into negative equity than a property purchased at the bottom of a cycle in the market. Property owners who took advantage of 100% mortgages, (that were so popular pre-financial crisis) were more exposed when property values fell.

What effect does negative equity have on the economy?

Mortgage default rates are more likely to increase as more home owners are in negative equity, meaning bad news for banks and lending institutions. Consumer spending is likely to remain low; a decrease in perceived wealth will affect consumer output.

Negative equity usually causes concern for property owners that wish to sell or for those whose current mortgage deal is coming to an end particularly if they have an interest only mortgage.

What can you do if your property is in negative equity?

    • Continue to own the property, pay the mortgage and hold off selling until property prices appreciate enough to regain equity.

 

  • Let the property out to cover the mortgage repayments, permission will likely be required from the lender and you will also have to find somewhere to live if the property is your residential home.

Some lenders provide schemes that can help property owners in negative equity to move, known as negative equity mortgages. These schemes can end up costing more than they are worth with higher interest rates, fees and larger repayments and will not be offered to everyone.

This is not a solution to the problem, as negative equity will remain but just concerning a different property. If the borrower has fallen behind on payments for whatever reason then lenders will refuse this option. These types of mortgage have been heavily criticised as they have a negative affect on both banks and consumers; the banks' balance sheets are affected and the property owners are taking on more debt, so it is debateable as to whether or not this is considered responsible lending by banks.

As long as the monthly mortgage repayments are affordable and you have no reason to sell the property, "negative equity" is solely a phrase and the paper value of the property is irrelevant.

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*This page is provided for information purposes only and should not be construed as offering advice. IPIN is not licensed to give financial advice and all information provided by IPIN regarding real estate should never be treated as specific advice or regulations. This is standard practice with property investment companies as the purchase of property as an investment is not regulated by the UK or other Financial Services Authorities.


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