CML news & views
Issue no. 15 - 12 August 2008
How much negative equity is there?
In a falling housing market, speculation often turns to prospects of negative equity.
Ratings firms, investment banks, researchers and politicians have all tried to put a finger on the number of borrowers in negative equity but there are no reliable sources of data on this.
Most estimates are based on movements in one of the house price indices and loan-to-value ratios of mortgages taken out before the downturn began. However, no one knows what has happened to the value of borrowers’ individual properties, or whether they have made extra capital repayments, and therefore we do not know whether they are nominally in negative equity or not.
A more worrying feature of recent reporting is the assumption some commentators are making of an automatic correlation between a borrower being in a position of negative equity and being at risk of possession.
One major national newspaper explained negative equity as “when the value of a property drops below the outstanding amount owed to a mortgage lender. This can leave home-owners facing repossession, or unable to move to take out a new mortgage.”
This is confusing two separate issues: what triggers the risk of possession is missed mortgage payments, not being in negative equity.
Negative equity is not a problem as long as borrowers are able to pay their mortgages, which the vast majority of them are doing. In the longer term, house price growth and capital repayments will take them back out of negative equity.
Recent trends in lending police are also helping protect both borrowers and lenders from exposure to negative equity. A year ago, the average first-time buyer paid a deposit of 10% of the price of the property; this has now risen to 13%. Although that does make affordability more challenging for some first-time buyers, it helps reduce the risk of negative equity.
In any case, negative equity is only a problem if the borrower is forced to crystallise this loss.
But it is incorrect to imply that borrowers in negative equity will automatically experience payment difficulty as a result. It is a ‘worst case’ scenario, that journalists naturally want to explore.
