Many homeowners may have welcomed the stratospheric rises in property prices we have seen this year, as they have increased the value of their most important asset.
The typical home was worth nearly £262,000 in May, according to the latest Halifax price index. This is £22,000 more than in May 2020.
Prices are tipped to fall once the stamp duty holiday ends in October – but although it might be disappointing to see your home’s value fall from this heady height, most homeowners will only be ‘losing’ theoretical money they never actually had.
First home: Do those stepping on to the property ladder need to worry about negative equity?
With house prices on a long-term upwards trend, most people who have owned their home for some time have already made a significant equity gain which potentially outstrips any short-term drop.
But for first-time buyers, it could cause bigger problems. Having bought a home at today’s inflated prices, they may be left in negative equity if values fall.
This is when the value of a home falls to less than what the owner owes on their mortgage it is a scenario which saw many people have their fingers burnt in the financial crisis.
It is a particular danger for those who have taken out loans with small deposits and have not been paying them off for long.
The number of people taking out low-deposit mortgages has increased in recent months, as lenders have re-launched products needing upfront payments of just 5 per cent.
‘Many first-time buyers would have been relying on high loan-to-value mortgages to secure their first property, and just a small drop in house prices could leave them at risk of negative equity,’ says David McGrail, director at broker First Mortgage.
New research by First Mortgage has found that almost two out of three first-time buyers are worried that their house will be worth less when they look to sell than the price they originally paid for it, while 42 per cent think negative equity will cause them issues in the future.
Should first-time buyers be worried about negative equity, and what can they do to avoid it?
As the post-pandemic price boom has shown, the housing market can throw you a curve ball and you can never be totally sure of what will happen to the value of your home in the future.
‘I don’t think anyone would have predicted the last year, let alone what the world will look like in another five’, says Matt Coulson of mortgage broker Heron Financial.
However, there are certain steps that first-time buyers can take to ensure that their risk of falling into negative equity is low.
Don’t overpay for your home
First of all, they need to make sure that the price they pay for their home reflects its true value.
If a buyer pays substantially more than their home is worth, perhaps to try and win a bidding war, the property will be more likely to receive a substantially lower valuation in future and risk putting them in negative equity.
‘When purchasing a property, you need to do your utmost to establish whether or not the property represents value for money,’ says McGrail.
‘Paying over the odds is the most likely cause of finding yourself in a negative equity situation.’
Negative equity is when the value of someone’s home is less than their outstanding mortgage balance
This may be tricky at the moment, as short-term factors such as the stamp duty holiday are inflating house prices.
But buyers can try and avoid it by comparing the price of their property against similar ones that have sold recently in the local area.
They may also want to opt for a house survey, over and above the valuation undertaken by their mortgage lender.
Make sure to choose one which includes a valuation as well as a condition report.
If the survey flags issues that need addressing, they can lower their offer to take that into account.
Going for a fixer-upper or a home in an up-and-coming area can also help to make sure a home increases in value.
‘If it’s the right time for you [to buy] and you are worried about negative equity, then make sure you buy a home that you know you can comfortably stay in for a few years and will not outgrow quickly,’ says Coulson.
‘It may be worth considering a property that you can improve and add value to, or even looking at up and coming areas that will go up in price.’
Make sure you get the right mortgage
For those buying with a lower deposit, choosing a shorter mortgage term could also help avoid the risk of negative equity – as long as it is still affordable.
This is because the monthly payments will be higher, and they will therefore build up equity quicker.
Interest only mortgages are best avoided, as the borrower will not be building up any equity in their home.
Borrowing more on a mortgage during the term, or taking a payment holiday, will also slow down the speed at which a homeowner builds up equity.
They could also consider saving for longer and putting down a higher deposit.
However, David Longhurst, director at Connaught Private Finance, says buyers considering this option should think about the other benefits of getting on the housing ladder sooner rather than later.
‘Concerns over negative equity will always play a part especially as a first time buyer, however I would urge perspective buyers to consider the overall picture,’ he says.
‘For those buyers who are renting, chances are that the mortgage payments will be less than their rent and they will be contributing to reducing the mortgage payments through their monthly payments as opposed to passing to their landlord.
‘If prospective buyers wished to take a more cautious approach then of course putting down a larger deposit will help mitigate this, but may take them longer to take that step.’
Don’t worry too much, say experts
While it is sensible to take precautions, Scott Clay of specialist mortgage lender Together says first-time buyers should not be unduly concerned about negative equity – provided they plan to stay in their home long enough to ride out any potential house price ups and downs.
‘Negative equity is only a moment in time,’ he says. ‘If house prices rise in future and your house increases in value, then you will come back out of negative equity through the natural ebb and flow of the UK property market.
‘So, for people not looking to sell their house for a considerable amount of time, it is not really something to worry about today.
‘While past performance of the housing market is not a guide to future performance, UK house prices have historically, tended to rise over time.
‘So long as people don’t borrow more on their mortgages, house price inflation alone should work in their favour to reduce negative equity.’
Coulson agrees that, as long as they are buying the right property, negative equity should not be a major concern for first-time buyers.
‘Don’t let yourself get too wrapped up on what might happen, just enjoy the fact that you are able to buy your own home,’ he says.
I am already in negative equity – how do I get out?
Given the house price rises are still ongoing, fewer homeowners will have found themselves falling into negative equity recently.
But if that is the case, there are several options they can take to reverse the situation.
In the First Mortgages survey, almost a third of people said that if their house was to fall into negative equity, that they would look to rent out their home in order to gain more money.
Alternatively, 42 per cent of people said that they would aim to find a higher-paid job.
While these are extreme actions, most people in this situation decide to either pay more towards their mortgage to increase their equity share faster, or simply stay put until the value of their home rises.
‘Negative equity is often looked at as this scary thing, but there are various things you can do to help the situation,’ says McGrail.
‘It is important to speak to a broker to understand your best way out of the situation, which ordinarily would be a plan to overpay your mortgage on a monthly basis to bring the outstanding mortgage balance beneath the value.’
Overpaying your mortgage is often the best way to get out of negative equity.
‘Mortgage lenders will allow borrowers to overpay their mortgage by around 5 to 10 per cent of the outstanding debt each year,’ explains Clay.
‘This can be a sensible use of any disposable cash and again, will reduce the level of debt and increase the borrower’s equity.’
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