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Millions face living in unsellable homes from property crash

·5-min read
negative equity
negative equity

Millions of homeowners face negative equity as interest rates rise and property prices collapse, leaving them unable to sell.

Britain’s post-credit crunch age of rock-bottom borrowing costs is at an end, while interest rates on some mortgages have doubled in a matter of months. The housing market faces a reckoning.

Prices are up more than 10pc in the past year, rocketing to a record 5.5 times the average wage - and even higher in London. Yet the looming end of ultra-cheap mortgages means buyers who have over-stretched themselves to the extreme are vulnerable to a spike in costs.

Worse still, those who bought recently and are buoyed by cheap debt could be heavily exposed to falling prices, which could send them into negative equity: when a property is worth less than the mortgage taken out on it, making it hard to move house or remortgage.

The phrase alone strikes fear into anyone who experienced the crunch of the 1990s when the property boom turned to bust.

Those who find themselves in the unenviable situation in which their mortgage debt is bigger than the value of their home are in a painful trap.

If they want to move, they would find their wealth has been wiped out - the proceeds of the sale insufficient to cover the debt.

If they want a new mortgage, lenders will refuse - raising the risk of being trapped on an expensive standard variable rate.

In 2013, in the wake of the financial crisis, the Financial Conduct Authority (FCA) found as many as 630,000 households were in this dire predicament. Prices fell by 18pc between the peak in 2007 and the trough in 2009, with the national average not recovering until 2014. Prices in the north east of England only overhauled their 2009 level for the first time at the start of 2021.

Even this crunch was small fry compared to the 1990s. After a boom in which prices jumped by more than 20pc per year in the late 1980s, the market fell for four straight years from 1990 to 1994.

By the middle of that decade, more than one-in-10 mortgage borrowers had more debt than their home was worth.

Now, house buyers have stretched themselves like never before to get a foot on the property ladder.

Prices surged more than 10pc over the past year, a pace not seen since before the financial crisis, to hit record highs month after month. The Office for National Statistics (ONS) puts prices at more than nine-times average earnings.

Affording this required larger deposits. Typically a first-time buyer has scrimped and saved for a deposit worth almost one-quarter of the property’s value, according to UK Finance, averaging around £60,000. It also required lower interest rates, with the base rate now 1pc even after a series of Bank of England hikes, compared to 4.5pc in 2005 and almost 15pc at its peak in late 1989.

A buyer with a 25pc deposit has a large cushion of equity which should preserve them from all but the most mighty of property crashes.

But a significant cohort, without such a pot of equity, is in a more precarious position.

One buyer in every six late last year had a deposit worth less than 10pc of their home, according to the Bank of England.

With more than 70,000 mortgages being approved each month, this translates to more than 11,600 small-deposit buyers, or roughly 135,000 per year.

While this may be fine in a market with rising prices, it is dangerous in a squeeze when a thin cushion of equity could be wiped out.

These borrowers are vulnerable now the market has started to turn.

Interest rates are rising. The Bank of England has hiked the base rate at each of the last four meetings, taking it from 0.1pc to 1pc, with more increases on the way.

It means the typical interest rate on a two-year fixed mortgage for a buyer with a 25pc deposit has almost doubled from 1.2pc in September to just over 2.3pc last month.

For those with a 10pc deposit, the rate is up from below 2pc at the start of the year to 2.6pc now.

Rates are only expected to get higher. Estate agents and surveyors are already finding this is causing demand for homes to slow - making it harder for those wanting to sell.

Andrew Wishart at Capital Economics expects the market to run out of steam this year before prices start to fall in 2023 and 2024.

Owners who bought at the right time to benefit from the boom should be safe. House prices are up one-fifth since February 2020, so even a buyer with the smallest of deposits in that month should now have a sizeable buffer.

Anyone stretching hard now, however, may have missed out on that opportunity.

Charles Goodhart, a former member of the Bank of England’s Monetary Policy Committee told MPs: “People who have borrowed at a very low rate and find the housing prices have been shooting up are not going to be in desperate straits. It's the new borrowers that I'm particularly worried about.”

If Capital Economics’ Wishart is correct and prices slip back - losing 5pc over 2023 and 2024 - those 95pc mortgage borrowers will find their equity squeezed over the next two years, with only their mortgage payments keeping them on the right side of the line.

If the fall in the market is deeper than Wishart anticipates, in a repeat of the past two major crunches, they risk falling into negative territory.

He points to evidence from the US that people keep paying their mortgage if they expect prices to recover - but not if they are deep under water.

“If you are only just in negative equity, then you have more hope prices will rise again at some point,” says Wishart.

“When you get declines of more like 20pc, that negative equity becomes forced sales. People sell the house and walk away from the mortgage.”

That would really drive the market into a crash.

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