Negative Equity

This expression came into general parlance in the late 1980s, when, for the first time in over 50 years, house prices fell on a consistent basis.

For two hundred years residential mortgages have been the prerogative of building societies. With an effective monopoly they tended to adopt similar, conservative lending policies. However, in 1980, the Government granted the clearing banks greater freedom and they were soon competing aggressively for mortgage business. As minimal regulations were then in place the mortgage market expanded rapidly while other overseas banks and insurance companies saw house prices rising steadily and added further funding of their own.

Many new mortgage lenders were also established. Without the expense of a branch network and relying on wholesale money sources at lower interest rates they introduced flexible, extremely generous and, as it soon transpired, short-sighted schemes.

Due largely to this extra funding house prices rose sharply and this trend generated wider inflationary pressures in the economy. Reluctant to restrict the housing market directly, the Government was forced to increase interest rates and it was not long before property prices in some areas were falling almost as fast as they had been increasing a year earlier!

Inevitably, once house prices and interest rates peaked, this left many people with extremely high repayment levels and mortgage debts which were greater than the falling market value of their property.

The personal capital put into a property purchase in cash – the difference between the price being paid and the amount of money borrowed on mortgage – is called ‘equity’. With falling prices this element soon disappeared – especially for those who had taken out a large percentage loan when buying the home initially – this left a shortfall which was soon called ‘negative equity’.

Negative equity was not necessarily a fatal problem. Reduced prices only effected those with a large amount outstanding on mortgage.  However, as prices fell further, more people became affected. In some areas prices fell by over a third with most areas seeing house prices at least 20% down on earlier peak levels.

By the early 1990s a significant proportion of home owners were in a situation where their outstanding loan exceeded the price the property was then likely to realise in the market. Negative equity became a major news story. In particular, it generated major problems in two areas – for home owners committed to a job-related move or those unable to maintain their escalating repayments.

To assist the former category, some lenders were able to assist by, effectively, transferring the negative equity to another property. This was possible where the borrowers had a strong personal covenant (q.v.) and were likely to be earning a higher salary after the move.

By far the worst problem thrown up by negative equity arose when possession proceedings were instituted by the mortgagees – the banks and building societies which saw the potential losses threatening their own commercial stability. When borrowers got into arrears the situation could deteriorate rapidly especially with house prices still falling. Lenders started to react quickly whenever a few payments were missed.

As these empty houses did not command premium prices, it has to be said, many lenders panicked. Especially the new electronic lenders which had few cash reserves and little market experience. They automated eviction procedures as they had automated most other aspects!

The result was a massive increase in the number of people being evicted as the courts, albeit reluctantly, granted the lenders a possession order. When all was paid and done, this procedure often left the former owners both homeless and verging on bankruptcy. Yet under the mortgage deed most were still liable for the outstanding shortfall – which the lenders were entitled to recover for a further period of six years.

Soured and embittered by this harsh treatment few of these people will ever want to own their own home again. And who can blame them?

With the gradual recovery of the housing market over the last few years negative equity is decreasing as a problem although the last 15 years has been a traumatic period for many. Presently prices are stable and maybe falling slightly but nobody expects another market collapse.