For many mortgage borrowers, negative equity is a term that is little understood. In a climate of rising house prices, such as that experienced in the UK during the late 1990s and early 2000s, negative equity barely exists.
When house prices stop booming, and start to drop, negative equity returns. For mortgage borrowers who are financially stretched with a large mortgage, negative equity is a realistic danger that needs to be understood.
Negative equity is when the value of an asset (such as a house) used as security in a loan (such as a mortgage) falls below the outstanding value of the loan.
How does negative equity occur in relation to mortgages and housing?
A mortgage loan is secured against a property, be it a residential dwelling, office or commercial building. A fall in the market value of the property is the most common cause of negative equity, although people can also fall into negative equity by obtaining further loans based on home equity. If the borrower can no longer afford to make repayments on the mortgage, the value of the property is worth less than the money outstanding on the loan. This is a classic example of negative equity.
Is negative equity common in the UK?
Negative equity in the UK was common during the economic recession of the nineties, and with the influence of the credit crunch in 2007-2008 negative equity returned to the UK.
Some borrowers that obtained high value mortgage loans, which were readily available whilst interest rates were low, face at a greater risk of negative equity if interest rates stay high and property prices fall.