Negative equity threat to 1.7 million properties

The spectre of negative equity on a scale not seen since the housing crash of the early 1990s is about to haunt the nation again, with unknowable but certainly dramatic political and economic consequences.

According to research from the Standard & Poor's credit agency, some 1.7 million homeowners – one in seven – will see the value of their home fall below the outstanding balance on their mortgage in the next year.

The gloomiest prediction circulating the City would see that number ballooning to 3.7 million households – almost one in three. Prices are already 9 per cent off their peak.

Meanwhile, and partly as a result of the widespread gloom around property, consumer confidence has fallen to lows last seen during the slump of the 1970s. Then, as now, consumers are facing steep rises in energy prices, the latest being Centrica's announcement of a 35 per cent rise in British Gas bills, with their electricity prices up by 9 per cent.

Many economists say inflation will top 5 per cent this autumn; even higher than the Bank of England has so far conceded likely, and way above the Government's 2 per cent target. The phenomenon of "stagflation" – stagnating output and unemployment coupled with high inflation – appears set to join negative equity in spooking the British economy out of its wits. The double witching hour seems nigh, and boom is turning to bust.

The scale of negative equity comes as a result of the sometimes reckless mortgages offered by banks and building societies at the peak of the boom – up to 125 per cent of a property's value in some notorious cases – and a predicted further fall in average house prices of 17 per cent by the end of 2009.

Although the extent of recent property price inflation will still leave many borrowers with a comfortable equity cushion, there will be some, especially buy-to-let investors who have purchased inner-city "regeneration" flats, who will be very badly burnt, losing perhaps half of their stake to negative equity in the worst cases. The rough average figure for the paper loss suffered by all those likely to be affected by the latest round of negative equity will be £12,500.

For those in secure employment and able to keep up their mortgage repayments, a negative equity loss is purely notional, though it may make moving home more difficult. However, a rising trend of joblessness and increases in mortgage rates for those coming off fixed-term deals suggests a much steeper rise in repossessions to come, leading to a further collapse in sentiment and a lethal downward spiral in the property market, similar to that gripping the US and Ireland and which helped plunge the UK economy into decline in the 1990s.

Economists agree that a severe house price crash will again tip the economy into recession. The Gfk/NOP monthly barometer of consumer confidence is at it lowest ebb since it started in 1974, with plenty of belt-tightening in evidence.

NOP say 42 per cent of shoppers have changed to supermarket own-brand goods, 28 per cent have moved to a discount supermarket chain, 41 per cent are going to pubs and restaurants less often and car journeys are down 50 per cent.

Currently, about 70,000 homeowners, or 0.6 per cent, are in negative equity – but the fall in house prices has hit every owner-occupier hard, and the average destruction in wealth since the top of the market last year is already about £13,500. The most pessimistic forecasters see prices dropping by 35 per cent from peak to trough – in which case S&P say about 30 per cent of homeowners – and more than half of buy-to-let and sub-prime borrowers – would owe more than their property is worth.