Mortgage calculator: is it better to rent or buy?

Negative equity is trapping thousands of homeowners every day, crippling the housing market and borrowers' hopes of moving. This week Halifax reported that average house prices fell by 2.3 per cent in February, equivalent to £135 a day. If this trend continues, five million households could be stuck in properties worth less than their mortgage debt by the end of the year.

Northern Rock, the state-owned bank, has already reported that a third of its mortgage book was in negative equity by the end of last year. Meanwhile, Lloyds Banking Group, which owns Lloyds TSB and Halifax, reports a sixteenfold rise in the number of borrowers with loan-to-value (LTV) ratios above 100 per cent since the begining of last year, climbing to half a million customers.

The pace with which house prices are falling is causing anxiety among homeowners, according to debt charities. Between October and January National Debtline received three times the number of calls about negative equity that it handled in the same period a year earlier.

But not all households need to worry. Your home is not at threat because you are in negative equity and homeowners who have no plans to move or remortgage need not panic.

David Hollingworth, of London & Country, the mortgage broker, says: “Negative equity occurs when house prices fall further than you can repay your mortgage debt. For millions of people it will simply be a case of riding out the problems in the housing market. But negative equity becomes a problem if you need a new mortgage deal, can't afford your mortgage repayments or have to sell your home.”

Here Times Money considers the options for borrowers stuck in the negative equity trap.

Remortgaging

Borrowers in negative equity will be inclined to revert to their standard variable rate (SVR) when their current deals expire. Successive cuts to the Bank of England base rate have sent SVRs to historically low levels, potentially saving some homeowners hundreds of pounds a month. But Aaron Strutt, of Chase De Vere Mortgage Management, another broker, says: “If borrowers can access a deal, they should consider locking in. Thousands are likely to be caught out if they are on a lender's SVR because, inevitably, rates will rise. If lenders get the opportunity to raise SVRs they will seize it.”

There are few deals for LTV ratios above 90 per cent, but lenders may be more flexible with existing customers. Halifax and Cheltenham & Gloucester (C&G), both part of Lloyds Banking Group, which is 43 per cent owned by the taxpayer, are happy to offer remortgage deals to existing customers in negative equity, though the rates are uncompetitive. C&G has a 6.59 per cent five-year fix with a £995 fee.

A Lloyds TSB spokeswoman said: “If we offered customers a 95 per cent deal in the past, then we believe that it is our obligation as a lender to help them when they come to remortgage.”

NatWest, owned by Royal Bank of Scotland, offers five and ten-year fixes up to 100 per cent LTV for existing customers who need to remortgage. Coventry Building Society also introduced a 100 per cent LTV deal for existing customers last week. It has a competitive rate of 4.99 per cent fixed for five years.

Most other lenders, including Abbey, Northern Rock, Nationwide Building Society and HSBC, refuse to offer remortgage deals to borrowers in negative equity.

Paying down your mortgage

Experts say that borrowers in negative equity should try to reduce their LTV ratio by overpaying. Most lenders will allow you to overpay by up to 10 per cent each month. Others cap the amount that you can overpay. For example, Nationwide limits overpayments to £500 a month.

Beccy Boden-Wilks, of National Debtline, the debt charity, suggests: “If you have a spare room, consider taking a lodger to raise money to pay down your loan. Earnings up to £4,250 a year will be tax-free.”

Borrowers should also ensure that they are making capital repayments rather than simply sticking to an interest-only deal. Mr Hollingworth says: “Paying only the interest while house prices are falling will only make it more likely that homeowners hit a problem later on.”

Moving out

Negative equity is a significant hurdle for homeowners who need to sell up, because the sale can lead to a substantial mortgage shortfall. If you need to move, a handful of lenders will allow you to “port” your mortgage to a new property. Lloyds TSB and Halifax allow porting, provided that you do not require additional borrowing.

Another option could be to move and rent your property to cover the mortgage payments. However, speak to your lender before considering this. Similarly, if downsizing is an option, you will need permission from your lender if you want to sell your home.

Homeowners who are struggling to meet their mortgage repayments face the prospect of being chased for the remaining debt if their house is repossessed and sold for less than the mortgage.

Ms Boden Wilks says: “In the last recession in the 1990s it was common for borrowers to give back their keys and walk away from their property. Borrowers did not realise that if there was a shortfall after the property was sold, lenders would chase the former residents for the outstanding debt.”

The Council of Mortgage Lenders (CML) estimates that half a million mortgage borrowers will be at least three months in arrears by the end of this year and 75,000 households will lose their homes over the next ten months.

Borrowers in negative equity who have their property repossessed often have the problem compounded by lenders. The sale of their property is often at auction, which means that it is even less likely to achieve a price sufficient to cover the full debt owed to the mortgage lender.

The last time that the UK housing market was hit by widespread negative equity, large numbers of lenders imposed charges for mortgage indemnity guarantees (MIGs), also known as a higher-lending charge. These were used to insure the lender against loss if it repossessed the home of a borrower in negative equity. The MIG would cover the difference between the property's sale price and the amount of outstanding mortgage debt.

However, Moneyfacts.co.uk, the financial website, says that few banks or building societies still include MIGs in the cost of their mortgages.

It found that less than 5 per cent of deals include a provision for loss on a repossessed property, suggesting that lenders are instead expecting to absorb the costs.

Banks and building societies can chase borrowers for mortgage shortfalls for up to six years after their home is sold or the last time that they had contact with the lender, under rules set out by the CML.

The balance owed to the mortgage lender is treated as unsecured debt and homeowners can be pursued through the courts. It is likely that the debts will also remain on your credit record if you fail to pay, which will hamper your ability to obtain a mortgage in the future. In some more extreme cases, former homeowners can even be forced to declare themselves bankrupt.

Homeowners who find themselves in negative equity and who can no longer afford to cover their monthly mortgage payments should seek help at the earliest opportunity, urge debt advisers.

Lenders will treat customers in negative equity in the same way as any other borrower and could be prepared to extend the term of your deal or switch to interest-only payments to lower your monthly costs.

Borrowers should also consult their local authority housing department or housing association.

Profitable spot of DIY

Homeowners who have edged into negative equity can reverse the downward slide with home improvements, which can raise the sale price and protect against a reduced valuation from your mortgage lender.

A recent survey found that spending about £1,000 on painting and decorating can add more than £3,500 to a home's sale price.

Clearing out clutter and tidying the garden can boost the value of your property.

Large projects can be a false economy and homeowners should think carefully before borrowing more cash against their property. On average, a home extension costs £33,800 but adds only £13,568, according to Abbey.

Case study - 'I can only hope that prices recover'

Ollie Sills is in negative equity. The 26-year-old bought his two-bedroom flat in Bristol for £221,000 in 2007, taking out a £207,000 offset interest-only mortgage with Intelligent Finance, which is owned by Lloyds Banking Group.

Mr Sills, pictured with his grilfriend, Jenn Lyle, extended his loan to £240,000 later in the year for home improvements. “It was an old student house and needed a lot of work,” he says. This boosted the value to £285,000, but it has since fallen in line with the national slide in property values. In December it was worth £235,000 and will now be below £230,000, he predicts.

“Negative equity is a real concern”, he says. “I don't plan to move soon, but it could be a problem down the line. I hope in two or three years prices will recover, but nothing is certain.”

Mr Sills is using the fall in interest rates to overpay on his mortgage. His repayments have dropped from £1,200 to £400 and the saving is going towards offsetting his loan.