Plot your course out of negative equity danger

A million homeowners are in the red but there is no need to panic, say Alessia Horwich and Julian Knight
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The Independent Online

Despite some signs of life in Britain's property market, the situation for many homeowners is pretty bleak. Recent Bank of England figures show that 1.1 million property owners in the UK are in negative equity – where their mortgage is higher than the value of their home.

That's almost as high a number as during the recession of the early 1990s. And there is no guarantee that the UK property market has turned a corner; in fact, more may slip into negative equity over the summer and autumn.

Many who bought at the top of the market have now seen house prices in their areas fall rapidly, leaving them with a house worth less than the amount they borrowed. However, in itself, negative equity is not a problem. It does not alter your mortgage repayments on your current deal and, as the market recovers, the problem will sort itself out in many cases. In fact, although the number of people in negative equity is similar to the early-1990s figures, the Bank of England points out that the total value of this negative equity is relatively small in comparison.

One factor preventing panic is the relatively low mortgage rates being charged by lenders. Repayments are often so low that overpaying is a viable option, and throwing as much money at your mortgage as you can afford is a good response to negative equity. "There's never been a better time to overpay your mortgage," says Heather Scott, a spokeswoman for Halifax mortgages. "Impacting upon your capital with mortgage rates where they are is much easier now than it has been historically."

Similarly, if you are on an interest-only mortgage and have slipped into negative equity, now is the time to switch to repayment to chip away at the capital sum borrowed. Property owners should be able to build up a good chunk of equity in their homes.

If overpaying is not an option and you need to secure a better mortgage deal despite being in negative equity, you are in a no-win situation. "If you are in negative equity at the moment your chances of remortgaging are zero," says Richard Morea from mortgage brokers London & Country. The highest LTV (loan to value) products on the market are at 95 per cent.

From the lenders' perspective, they are taking the property as security and it is simply too much of a risk for them to lend more than the value of the property. However, as long as you can meet repayments, record low standard variable rates mean most have the luxury of putting off a remortgage, at least in the near future.

What's more, selling up in a downturn is itself fraught with dangers when it comes to getting back on the ladder: "Even if you are able to absorb the downturn in house prices," says Mr Morea, "you've got to look at what will happen in your onward move. If you are looking at a high LTV, then you might be much worse off in the long run when it comes to buying another property, if you can get a mortgage at all."

If all other options have been exhausted and you do sell while in negative equity, the outstanding debt will still be owed at the commercial rate at which it was borrowed and an arrangement will be made with the lender to repay this.

Before you get to this stage, there are several options available. Renting out a room can be, for many, a quick fix that provides a tax-free income up to £4,250 per year. However, be aware that if you take in a lodger you will have to tell your contents and buildings insurer of the change of circumstance; if you don't and have to make a claim, you may find that it is rejected.

If renting out a room will not bring in enough cash, property owners can consider moving out of their home and renting it out. But as far as your mortgage lender is concerned, this can be problematic.

You will have to switch from a residential mortgage to a buy-to-let one. Before the credit crunch, that wasn't a difficult transition. But since late 2007, lenders have seen many buy-to-let investors struggle to meet their mortgage payments. In fact, buy-to-let investors are about four times more likely to default on a mortgage than an owner-occupier. Lenders are now asking buy-to-let borrowers to jump through more hoops before they will agree to the loan.

Those looking to switch to buy-to-let will usually need a substantial deposit, sometimes as high as 30 per cent. In addition, many products require rental income to cover at least 130 per cent of the mortgage payments. These criteria are a tall order for those in or even close to negative equity. Their LTVs are high, and if their properties are not designed specifically for rental they could have problems achieving the needed rental income. However, if you stay with your current lender, it may look sympathetically at you, in effect waiving some of the criteria which would apply to a normal buy-to-let investor. As Ms Scott says: "If you are coming in as a new customer then the criteria apply, but if you are in financial difficulty and renting is a viable solution to help you recover from the situation, then banks will work with the customer to try to make it happen."

In the past six months, the Government has introduced help for those struggling with mortgage repayments. The Support for Mortgage Interest scheme will pay the interest on the mortgages of those who have lost their jobs and qualify for various benefits.

To date, though, government-backed initiatives have been criticised for taking an age to set up and consequently failing to help many homeowners in crisis. Perhaps of more help is the undertaking of many of the UK's biggest lenders to keep people in their homes, even if several mortgage payments have been missed.

According to most debt and housing charities, negative equity can really bite when personal circumstances change, in particular, being made redundant or being unable to work due to ill health or injury. If you're unable to meet mortgage repayments, repossession can follow. And if you're in negative equity, you can still owe the mortgage company money. An emergency savings cushion of between three and six months' salary can make a huge difference, as can buying income protection insurance, which will pay an income should you lose your job.

Stuck: 'We're busy building equity'

Georgina Foggin, 27, a solicitor from Sutton Coldfield, bought a house with her partner in May 2005, straight after graduating. They did not have a deposit and obtained a 100 per cent mortgage on a three-year fixed interest-only deal from HSBC. The couple are now in negative equity but not all is doom and gloom.

"We've just come to the end of our three-year interest-only fixed deal, but because the SVR is so low (1 per cent above base rate), we are fortunately able to overpay significantly. We also haven't fallen too far into negative equity because we've done quite a lot of work to the property. As we are stuck here for the time being, we think it's a great way not only to add value, but also make it a nicer place for us to live in.

"One of the things that has come out of this is that we are more careful. We are not looking to move to a bigger property simply because we want more space. Instead we can see that it's more important to try to build up the equity in your property before moving on, which is what we are concentrating on now."

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