What is Negative Equity?

Full Definition

Negative equity occurs when the current market value of a property falls below the outstanding balance of the mortgage secured against it, meaning that if the property were sold at that value, the proceeds would not be enough to repay the mortgage in full, leaving the owner needing to find the shortfall from savings or other funds simply to complete a sale. It typically arises after a period of falling house prices following a purchase made with a small deposit (high loan-to-value), since a borrower who put down only 5-10% has very little buffer before a modest price fall wipes out their equity entirely, whereas someone with a large deposit or years of capital repayments has more headroom before the same price fall pushes them into negative equity. Being in negative equity does not, by itself, cause any immediate problem for a homeowner who can continue making their mortgage payments and has no need to move -- the mortgage continues as normal, and negative equity only becomes a practical issue when the owner wants or needs to sell, or wants to remortgage. Selling while in negative equity requires either finding the shortfall from other savings, negotiating a "shortfall sale" or "assisted voluntary sale" with the lender (where the lender agrees to release the property despite the sale not fully repaying the mortgage, sometimes converting the remaining shortfall into an unsecured loan), or waiting until prices recover or enough capital has been repaid to move back into positive equity. Remortgaging is also affected, since most lenders require a maximum loan-to-value for a new deal, meaning a borrower in negative equity typically cannot switch lender and instead reverts to their existing lender's standard variable rate (or, in some cases, a limited "product transfer" option with the existing lender) until their equity position improves. Worked example: a first-time buyer purchases a flat for £200,000 with a 5% deposit, taking out a £190,000 mortgage; if the local property market then falls by 10%, the flat is worth £180,000 while £185,000 or so is still owed after a year of interest-heavy repayments, leaving roughly £5,000 of negative equity -- the owner can still live in the flat and keep paying the mortgage as normal, but could not sell or remortgage onto a new fixed rate without either finding the shortfall or waiting for prices to recover or the mortgage balance to reduce further.

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