The reason is the fall in house prices, which slipped back by an average of1.7 per cent in the fourth quarter of 1994, according to recent figures from Halifax Building Society.
However, UBS predicts better news on the horizon. It forecasts that house prices will rise by 6 per cent during 1995 and even faster in the South-east, where negative equity is most prevalent.
"We are quite bullish," says Rob Thomas, UBS's housing analyst, who compiled the report.
Mr Thomas predicts that the number of negative equity sufferers will fall to 700,000 by the end of this year and that negative equity will disappear altogether by the end of 1997. Figures show that every 1 per cent increase in house prices removes 100,000 people from the negative equity trap.
The number of people caught in the trap hit a peak of 1.8 million in the first quarter of 1993. Mr Thomas, who calculated the Bank of England's statistics on negative equity before joining UBS last year, says the average level of negative equity is £5,000. However, some 210,000 homeowners have a shortfall of more than £10,000 and 5,000 people have negative equity of more than £20,000.
UBS blames the short-term rise in the number of home-owners suffering from negative equity on the "feel-bad" factor, which is affecting the housing market.
The figures are due to rise in the first quarter of this year as this is traditionally a weak period for activity in the housing market, before picking up in the spring.
The biggest regional increase was in the South-east (excluding Greater London) where there was a 9 per cent rise in the number of homeowners dragged into the equity gap. This represents an additional 42,000 homes.