Frankly, negative equity is a frustrating and confusing point in the mortgage process. It happens when a mortgage is worth less than what is owed on it. This can be somewhat tolerable if it occurs at the beginning of the mortgage term and a person has time to make up the difference. However, it can be devastating?and even a deal-breaker?if the shortfall happens at the end of the term, making it more equivalent to foreclosure than a short sale.
This is why potential homeowners need to know what negative equity and its repercussions are, especially if they want an opportunity to renegotiate their mortgage payments.
What is Negative Equity?
Negative equity happens when a home's current market value is less than what is owed on it. In other words, when a person owes more on the property than it is currently worth, they are in negative equity. This is sometimes called being "upside down.”
How to Know if You're in Negative Equity
The first step to taking action is to find out what's happening with your mortgage, which means knowing the actual value of your property. This will give you a realistic idea of your property's market value. These sites track sales of similar homes in the area and factor in realtor commissions, mortgage interest rates and closing costs into their estimated market value.
Once you know your home's estimated market value, you can determine whether you're in negative equity. Take the value of your loan and subtract your home's value. If the result is a negative number, you can start exploring how bad your negative equity is and what you can do to fix it.
It's also a good idea to speak with a conveyancer to help plan your next steps.
Who is at Risk of Negative Equity?
People often assume that negative equity happens only to people who have downsized or taken out a subprime mortgage. However, it can happen to anyone whose home has deteriorated in value. This can happen for various reasons, such as an economic downturn or neighbourhood gentrification.
Additionally, people with adjustable-rate mortgages can be at risk of negative equity if their interest rate is adjusted upward and the value of their property hasn’t rebounded.
How does Negative Equity Affect Your Mortgage?
When you’re in negative equity?in other words, your mortgage loan amount is higher than the actual value of your home?this means that you have unsecured debt. Simply put, you are responsible for paying off the difference between your mortgage loan and the value of your home, and this can be a crippling financial burden. Let's explore how it can affect specific mortgages.
With an interest-only mortgage, if you’re in negative equity, you may need to pay a higher interest rate the next time your interest rate adjusts. Typically, your interest rate may adjust before your mortgage loan is almost paid off.
If you have a fixed-rate mortgage and you’re in negative equity, you can ask your lender to consider a short sale or a loan modification. If they won’t approve either of these options, you may have to bite the bullet and pay off the entire remaining amount of your loan.
Tracker mortgages are loans whose interest rate moves in line with the property interest rate index. In general, if you're in negative equity on a tracker mortgage, you will have to ask your lender for a loan repayment plan or for a loan transfer to a new home.
How to Remortgage When in Negative Equity
There are various ways to get out of negative equity, but the easiest and most efficient way is to remortgage. There are two ways to do this:
Ask Your Current Lender for a Loan to Value Break. If you have a fixed or tracker mortgage, you can ask your lender for a loan to value break or LTVB. In other words, you can ask for a new mortgage on a new property that has a higher LTV. This can often be completed in one day, unlike trying to sell your home.
Transfer Your Current Mortgage to a New Loan. If you want to keep the same property but lower your monthly payments, you can remortgage to a new loan. Because you're already in negative equity, getting a fixed-rate mortgage with lower payments is a great time.
Alternatives to Remortgaging
If you’re looking to avoid a remortgage and you have a subprime mortgage, you can try these strategies to get out of negative equity:
If you have a subprime mortgage, you can consolidate it into a conventional first mortgage. Keep in mind that you may need to pay a higher interest rate and/or a higher fee for this option.
If you can sell your home for less than what you owe on your mortgage, you may be able to make a short sale. A short sale is when you sell your home for less than what you owe on your loan, and you agree to allow your lender to forgive the remainder of the loan. This is also known as an “off-market” sale.
Warning Signs of Negative Equity
Be wary of certain warning signs that you may be in negative equity, such as:
If a property agent suggests a price well below what you owe on your mortgage to entice a buyer to purchase your home.
If your monthly mortgage payments are more than your monthly income.
If your home has lost significant value even as the market in your area has increased.
If the value of your home is significantly below what you owe on your mortgage.
The Help to Buy Equity Loan
The Help to Buy Equity Loan (or Help to Buy scheme) is a government scheme that allows first-time buyers to purchase a new home with a 5% deposit. The government loan is interest-free for the first five years and is then charged at the prevailing mortgage rate.
Get Out of Negative Equity
If you've found yourself in negative equity, it's important to know your options and the potential consequences. Whether you're planning to sell and move on or you want to keep your home and make a few changes, you can explore your options and decide on a plan that is right for you. In addition to speaking with a conveyancer, it's important to speak with a mortgage consultant who can review your financial situation and help you understand the options available to you. While you're in negative equity, you have the option to explore a mortgage modification, a short sale, or a refinance.
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