The number of households with property worth less than their mortgages dropped by 100,000 in the first three months of the year, according to UBS, the City securities firm.
Rob Thomas, a UBS economist, said the fall from 1.3 million to 1.2 million suggested a more robust housing market in the quarter. The average negative equity - shortfall between house value and mortgage - also fell to £4,700 from £5,000 at the end of last year.
But cuts this month in mortgage interest relief and income support could bring a setback because they fall disproportionately on households with negative equity, he added.
However, UBS still expects a further fall in the numbers with negative equity in their houses to 700,000 by the final three months of this year, because of a recovery in house prices in the South, where negative equity is most widespread.
The number with negative equity is 100,000 lower than a year ago and 600,000 lower than the peak in the first quarter of 1993. The shortfall between the value of homes and of the mortgages taken to buy them fell £800m to £5.5bn in the first quarter of this year, less than half of the peak figure of £12bn two years ago.
Householders in the South who bought at the peak of the boom in late 1988 have been in the negative equity trap for six years and are likely to be among the last to get out of it.
The largest regional fall in households with negative equity was in the South-east, excluding Greater London, where the number was down 57,000. There were also falls in Greater London, East Anglia, the West Midlands, the North-west, Wales and Scotland. But in the South-west, East Midlands and Yorkshire and Humberside, negative equity increased.
Mr Thomas said: "Negative equity appears to have stabilised, and a modest increase in house prices this year could make significant inroads into the problem. The only serious threat to this recovery comes from changes in government support for owner-occupation in the form of reduced income support."