The right time to buy smart

Overstretched first-time buyers are especially vulnerable in a falling market. Stephen Pritchard explains why

The double whammy of higher interest rates and pricier properties finally appears to have taken the heat out of much of the property market. Figures published last week by the Bank of England showed that the number of new mortgages fell to its lowest level since 2002, with 77,000 new loans agreed, adding further weight to the argument that property prices will fall over the coming year.

The double whammy of higher interest rates and pricier properties finally appears to have taken the heat out of much of the property market. Figures published last week by the Bank of England showed that the number of new mortgages fell to its lowest level since 2002, with 77,000 new loans agreed, adding further weight to the argument that property prices will fall over the coming year.

If prices do fall, some homeowners will be saddled with negative equity - namely, mortgages that are larger than the value of their homes. Especially vulnerable are buyers who stretched themselves to the limit, taking out a 100 per cent mortgage.

Potentially worse off still are those buyers who took out a mortgage in excess of 100 per cent of the value of their home. Some will have used these loans to improve or extend their houses. If this has added value, they will have some protection against negative equity. But if they used the money to pay off other debts, they will be vulnerable to any fall in house prices.

According to David Hollingworth, director at mortgage brokers London & Country, it is first-time buyers who are most exposed to any fall in house prices, as they are the ones who will have stretched themselves most to gain a foothold on the property ladder.

He adds, however, that negative equity only really becomes a problem for buyers if they need to sell, or move immediately, and face doing so at a loss.

"If you can ride it out it may give you sleepless nights, but it is more of an academic issue unless you really need to move."

When first-time buyers slip into negative equity, it affects their ability to move up the property ladder. Almost everyone starts with a property that is smaller than they would really like, with the plan to trade up in the future. Rising prices help them to build up equity and make the jump easier. Falling prices have the opposite affect.

Homeowners are also vulnerable if they are forced to sell, either because they have fallen behind with their mortgages, or because they have to move for work or personal reasons.

In 1991, at the height of the last house price recession, 75,000 homes were repossessed. Interest rates then were significantly higher than they are now, but this is cold comfort for families who spent years repaying debts on homes they no longer owned. If someone's home is repossessed and it is in negative equity, they will have to repay the original loan, not the amount the lender eventually sells it for.

Homeowners who need to sell in order to move also face difficulties. They might not be able to transfer their mortgage to a new property if values have fallen, as the loan may exceed the lender's loan-to-value rules.

In order to move, buyers would then have to pay off some of the mortgage in cash to keep the loan to, say, 90 per cent of the new home's value. And there is no guarantee that the new home will hold its value, either.

Mr Hollingworth cautions that both movers and first-time buyers could be more exposed to falling house prices in the coming year than buyers who bought even as recently as one or two years ago, and who have built up some equity. Although last year saw house price inflation ease, this year many economists expect prices to fall in absolute terms.

"Anyone looking to go into the market now cannot look forward to the kind of growth we have seen recently," says Mr Hollingworth. "If prices drop back they will have no equity to play with."

There are, however, steps that buyers can take to protect their positions. One is to buy smart. Driving a hard bargain with sellers is possible in the current market. And being ready to move, with all your finances in place, will also help you negotiate a good, quick deal. Another is to overpay on the mortgage. Even repaying an extra £50 a month can quickly build up some equity, and has the added benefit of cutting the total interest bill.

But there may not be cause yet for panic. We have been here before: in both late 1999 and 2002 experts predicted house price falls. Both years ended with significant price rises.

"Slight falls [in house prices] are forecast, but they are minimal and follow several years of exceptional growth," says Paul Fincham, a spokesman for the Halifax.

"Past major housing market downturns have all been caused by a combination of economic recession, steeply rising unemployment and significant rises in interest rates directed at controlling retail price inflation. There is very little likelihood of a similar combination occurring over either the short or medium term."

And one thing remains certain. Over anything but the shortest term, paying rent to a landlord is throwing money away.