Should first-time buyers worry about negative equity when property prices are high?

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Many homeowners may have welcomed the stratospheric rise in property prices this year as they increased the value of their most important asset.

According to the latest Halifax Price Index, the typical home was worth nearly £ 262,000 in May. That is 22,000 euros more than in May 2020.

Prices are likely to fall once the stamp duty ends in October – but while it could be disappointing to see the value of your home drop from this heady high, most homeowners will only “lose” theoretical money they never had.

Primary Home: Do Those Climbing The Real Estate Ladders Have To Worry About Negative Equity?

With a long-term uptrend in home prices, most homeowners have already made significant equity gains that may outperform a short-term decline.

But it could cause bigger problems for first-time buyers. After you’ve bought a house at today’s inflated prices, it can remain in negative equity as values ​​fall.

This is a scenario where many people got their fingers burned during the financial crisis when the value of a home falls below the mortgage the owner owes.

It is a particular danger for those who have taken out loans with small deposits and have not long paid them off.

The number of people taking out low deposit mortgages has increased in recent months as lenders have relaunched products that only require a 5 percent prepayment.

“Many first-time buyers would have relied on high lending value mortgages to secure their first home, and even a small drop in home prices could put them at risk of negative equity,” said David McGrail, director of Broker First Mortgage.

New research from First Mortgage found that nearly two in three first-time buyers fear that their home will be worth less than the price they originally paid for it when sold, while 42 percent believe negative equity will cause them problems in the future.

Should first-time buyers be concerned about negative equity and what can they do to avoid it?

As the post-pandemic price boom has shown, the real estate market can give you a curve ball and you can never be entirely sure what will happen to the value of your home in the future.

“I don’t think anyone would have predicted last year, let alone what the world would look like in another five,” says Matt Coulson of mortgage broker Heron Financial.

However, there are certain steps first-time buyers can take to ensure their risk of running into negative equity is low.

Don’t pay too much for your home

First of all, they need to make sure that the price they are paying for their home reflects its true value.

If a buyer pays significantly more than their home is worth, perhaps to win a bidding war, the property is more likely to receive a significantly lower valuation in the future and run the risk of falling into negative equity.

“When you buy a property, you must do everything possible to determine if the property is good value for money,” says McGrail.

‘Paying over the quotas is the most likely reason to find yourself in a negative equity situation.’

Negative equity is when the value of a person's home is less than their outstanding mortgage balance

Negative equity is when the value of a person’s home is less than their outstanding mortgage balance

This can be tricky right now as short-term factors such as stamp duty vacations drive house prices soaring.

However, buyers can try to avoid this by comparing the price of their property to similar properties recently sold nearby.

You can also opt for a home viewing that goes beyond the assessment made by your mortgage lender.

Be sure to choose one that includes both an assessment and a health report.

If the survey shows any issues that need to be addressed, they can reduce their offerings to take them into account.

Choosing a fixer-upper or a house in an up-and-coming area can also help add value to a home.

‘When the time is right for you [to buy] and you are worried about negative equity, make sure you buy a home that you know you can stay in comfortably for a few years and that won’t grow out of it anytime soon, ”says Coulson.

“It may be worth considering a property that you can upgrade and upgrade, or even look for emerging areas that will go up in price.”

Make sure you are getting the right mortgage

If you buy with a smaller investment, you can also avoid the risk of negative equity by choosing a shorter mortgage term – as long as it is still affordable.

This is because the monthly payments are higher and therefore they build equity faster.

Interest rate mortgages are best avoided as the borrower will not build equity in their home.

Increased borrowing during the term or a paying vacation will also slow the rate at which a homeowner builds equity.

You could also consider saving longer and making a larger deposit.

However, David Longhurst, director at Connaught Private Finance, says buyers considering this option should think about the other benefits of moving up the real estate ladder sooner rather than later.

“Negative equity concerns will always be a factor, especially as first-time buyers, but I strongly encourage potential buyers to look at the bigger picture,” he says.

“For buyers who rent, there is a chance the mortgage payments will be less than their rent and they will help reduce the mortgage payments through their monthly payments rather than passing them on to their landlord.

“Obviously, if potential buyers want to take a more cautious approach, paying a larger down payment to mitigate this will help, but it may take longer for them to take this step.”

Don’t worry, experts say

While it makes sense to take precautions, Scott Clay of specialist mortgage lender Together says that first-time buyers shouldn’t worry unduly about negative equity – provided they plan to stay in their home long enough to avoid potential up and down movements in property prices to survive.

“Negative equity is only a moment,” he says. “If future house prices rise and the value of your home increases, the natural ebb and flow of the UK property market will bring you out of negative equity.

“So for people who are not planning to sell their home for a considerable amount of time, this is nothing to worry about today.

‘While past property market performance is not an indication of future performance, UK property prices in the past have tended to rise over time.

“As long as people stop borrowing for their mortgages, house price inflation alone should work in their favor to reduce negative equity.”

Coulson agrees that negative equity shouldn’t be a huge problem for first-time buyers as long as they buy the right property.

“Don’t get too preoccupied with what could happen, just enjoy the fact that you can buy your own home,” he says.

I already have negative equity – how do I get out?

With house price hikes still ongoing, fewer homeowners will have slipped into negative equity lately.

But if they do, there are several options they can take to reverse the situation.

In the First Mortgages survey, nearly a third of respondents said that if their home fell into negative equity, they would try renting out their home to make more money.

Alternatively, 42 percent of respondents said they would want a higher-paying job.

While these are extreme measures, most people in this situation choose to either pay more for their mortgage to increase their equity ratio faster, or just stay that way until their home goes up in value.

“Negative cheapness is often viewed as a scary thing, but there are several things you can do to improve the situation,” says McGrail.

“It is important to speak to a broker to see how best to get out of the situation. Typically, you would overpay your mortgage monthly to bring the outstanding mortgage balance below value.”

Overpaying your mortgage is often the best way to get out of negative equity.

“Mortgage lenders will allow borrowers to overpay their mortgage by about 5 to 10 percent of their outstanding debt each year,” Clay said.

“This can be a sensible use of available cash and will in turn reduce debt and increase the borrower’s equity.”

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