Negative equity is when you owe more on your mortgage than your home is currently worth.
Equity is the percentage of your home that you own. The initial equity you hold comes from your deposit, which is why larger deposits are recommended.
You then build up equity over time as you repay the mortgage, and when your property value rises. Unless you have an interest-only mortgage, in which case you only gain equity with a rise in property value, as you’re not repaying any of the debt.
If there is a fall in your property value, you’ll lose equity, even though you’re still repaying the loan. When your property value falls below the outstanding balance on your mortgage, you’ll enter negative equity.
The most common reason for falling into negative equity is a fall in property prices. However, it’s easier to fall into negative equity if:
You used a small deposit - or no deposit (100% mortgage) - to buy your home
You have an interest-only mortgage
You leave your house to fall into disrepair - meaning it will lose value more easily
You’re in arrears on a repayment mortgage
The larger your loan size - so, the smaller the deposit - compared to the value of the property, the more vulnerable you are to negative equity. This is referred to as the loan-to-value ratio (LTV) of your borrowing.
Generally, property prices tend to rise over time, rather than fall. However, it’s certainly a possibility and more likely when the country is in a recession, as this is when property values tend to fall the furthest.
Negative equity example:
You buy a home worth £200,000 with a 5% deposit (£10,000)
You’re borrowing £190,000 (95% LTV) so have 5% equity
The property value falls to £180,000 when you will still owe £190,000
You’re in negative equity - you owe £10,000 more than your home is now worth
If you’ve not yet bought a home, there are a number of ways you can reduce the chances of falling into negative equity:
Use a larger deposit - the more you can afford to offer, the more equity you begin with, meaning there’s further to fall before you hit negative equity
Make sure you’re getting the property at market value, don’t pay over the odds
Buy when prices are low - monitor the market and seek expert advice
Use a repayment mortgage - interest-only products are riskier as you’re not gaining any equity unless the property price goes up
If you have no plans to move or remortgage, being in negative equity for a short time shouldn’t cause too much of an issue.
To reduce your negative equity you could:
If affordable, try to make mortgage overpayments, this will help you regain equity more quickly - be aware of overpayment limits, however, as you may incur charges
If you’re on an interest-only mortgage, ask your lender if you can switch mortgages to a repayment plan. Most lenders are happy to do this as it lowers the risk in their lending - this way you can gradually rebuild your equity over time
Wait for property prices to rise - usually this will happen in the long-term, but it could be troublesome if you want to move or remortgage soon
Improve your property to increase its value - although bear in mind the increased risk in borrowing additional funds to do so
Negative equity mortgages are a specialist mortgage that allows you to transfer your negative equity to a new home.
These are only offered by a handful of lenders, but it’s a possibility if you’re in negative equity and desperate to move home. A mortgage broker should be able to help you find one.
You can move house without having to repay the negative equity, as it’s transferred to the new property
Usually you won’t be able to remortgage when you’re in negative equity, but there may be some lenders willing to do a product transfer. Not all lenders ask for a property valuation if you’re simply moving from one product to another.
However, keep in mind that even if you can find a product transfer with your existing lender, they won’t necessarily have a cheaper rate available.
If you’re looking to remortgage to borrow more money, you won’t be able to do this in negative equity. This is because your equity is used as a deposit for additional borrowing.
It’s also important to understand that even when you’re not in negative equity, if you remortgage to borrow more, you’ll have a greater chance of falling into negative equity in the future, as you’re reducing the equity you hold by increasing the loan.
It’s important to continue paying whatever you can afford if you're unable to make full mortgage repayments, as this will minimise the debt you accumulate. Get in touch with your lender as soon as possible, as it’s much better to be honest about the situation.
Most lenders will be keen to help customers continue repaying their mortgage, and will be able to offer recommendations on how to cope when you can’t afford your mortgage repayments.
There are also a number of debt charities that may be able to help you:
If you’re hoping to sell your home to get out of negative equity, it’s unlikely that this will be possible - and will be harder, the larger the value of your negative equity. You can sell your home, but you won’t be able to sell it above market value.
If your property value has fallen, the resale price you get won’t fully repay your mortgage. You’ll still owe whatever mortgage you took out to buy the property at a higher price (minus any repayments you've made).
This means that you would need to repay the remaining debt to your lender even after you’d sold it. Lenders may allow you to set up a payment plan to do so, but buying a new home whilst you do so won’t usually be possible.
It can be difficult to move home if you’re in negative equity, unless you’re able to repay the difference. There are a few negative equity mortgages available, but these are offered at high interest rates, and fairly hard to come by.
The good news is, so long as you continue to make mortgage repayments, being in negative equity will not affect your credit score.
You’re still repaying the agreed debt, so from the credit reference agency’s perspective, there isn’t an issue.