If house prices crash owners who cannot keep up with their mortgage could face repossession. Others could fall into negative equity. This is a growing worry, with experts predicting the market will fall to 2013 levels as mortgage rates soar.
Negative equity happens when house prices fall and a property is worth less than the remaining value of the mortgage taken out to buy it.
Someone who buys a £300,000 property with a 90 percent loan-to-value (LTV) mortgage of £270,000 starts off with £30,000 of positive equity.
If the property falls 15 percent to £255,000 while the mortgage only shrinks to £265,000, they will then have £10,000 of negative equity.
Borrowers who bought recently with a 90 or 95 percent loan-to-value mortgage could get caught if prices drop 10 percent.
Those who bought a year ago may have some protection as prices have still climbed around 10 percent since then.
More recent buyers are the most vulnerable.
Negative equity is only a major problem if you need to sell, said Mark Harris, chief executive of mortgage broker SPF Private Clients. “Up to that point you are sitting on a ‘paper loss’, with no obligation to pay more money into the mortgage to reduce the LTV.”
Most owners should therefore sit tight if they can and wait for values to recover, said Jonathan Harris, managing director of mortgage broker Forensic Property Finance. “It may take some years, but prices will eventually recover and recent buyers could even enjoy capital appreciation over time.”
Any homeowner who cannot keep up with mortgage repayments is in big trouble, though.
If you decide to sell, you need to cover any shortfall between the outstanding mortgage and the sale value of your home, Harris added. That is a real problem if you are in negative equity.
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First-time buyers with small deposits are more likely to fall into the trap, said Karen Noye, mortgage expert at wealth manager Quilter.
Couples who bought together then split up are also vulnerable. “It could be impossible for one to buy the other out, while they could face a shortfall if they try to sell the property. Plus they won’t have any equity to put towards new accommodation,” Noye said.
Those who cannot maintain mortgage payments as interest rates rocket are in the worst position.
“The lender would repossess their home and ask them to pay back the difference between sale price and outstanding mortgage, plus any additional costs. This could leave someone in a spiral of debt,” Noye said.
Repossession is particularly tough on buyers in the UK. In the US, they can simply hand back the keys to their property, but things work differently over here.
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As well as handing back the property, you also have to cover any shortfall between what you owe and how much the lender manages to recoup when it sells the property.
It leaves buyers in a double bind.
They need to take advice before doing anything drastic. Citizens Advice can help.
Debt charity StepChange says it is almost always better to put the property on the market and sell it yourself, as you will get a better price than if you leave it to your lender to sell.
Your bank or building society is likely to put it up to auction to secure a quick sell, knowing that the borrower is on the hook for any shortfall.
Surrendering your property should only ever be a last resort. If you are in negative equity and in danger of falling behind on your repayments, talk to your lender. It may help you set up a payment plan.
If worried, don’t stick your head in the sand and leave action until it’s too late.