Negative equity is when the value of a property is less than the outstanding debt secured against it. But what options exist for buy-to-let landlords who are stuck in negative equity?
Figures suggest that roughly half a million properties in the UK are in negative equity. Many of these property owners will have bought at the peak of the market last decade, before prices fell. Being in negative equity makes it almost impossible to sell or refinance a property without first settling the shortfall.
Negative equity is more likely to be a problem for homeowners than for property investors. This is because buy-to-let mortgages require larger up-front deposits than owner-occupier loans. This said, many buy-to-let loans are interest-only, putting the owner at risk of falling prices. And some landlords are former owners who let out a property they were unable to sell because of negative equity.
There are a few options for dealing with negative equity, each with its own pros and cons.
Use savings to reduce the size of your buy-to-let mortgage
You can use savings, or equity from other properties, to pay off a chunk of your mortgage. A lump sum payment may be enough to put the loan back into positive equity straight away.
Overpaying can reduce the amount of interest and shorten the mortgage term. But property is illiquid, and cash tied up in equity becomes difficult to access if needed. Repaying part or all of a mortgage may also attract early repayment charges (ERCs).
Consider whether the benefits of reducing the loan outweigh the losses elsewhere. Savings might be better spent clearing other debts or leaving as a contingency fund. You might even be better off using the money to renovate the property. This could improve its value and perhaps even its rental yield.
Instead of one lump-sum repayment, you can make regular overpayments. Many lenders permit borrowers to do this, up to a certain amount, without penalty. There are also flexible products that allow borrowers to overpay as much as they like.
Regular overpayments steadily reduce the size of the debt. Like lump-sum repayments, they can enable you to shorten the term or decrease the interest repayments. If you have the luxury of time, overpayments can achieve the same outcome as one large repayment without needing the same level of commitment.
If using rental income to make overpayments, remember your other overheads. You will still need cash flow to deal with repairs, fees and other business expenses.
Use savings to refinance
You can also use savings or cash from elsewhere in your portfolio as a deposit towards a new loan.
In most cases, the equity in a property acts as a deposit when the owner remortgages. But this is impossible in the case of a property that is in negative equity. The deposit must come from elsewhere.
A landlord buys a property worth £150,000 with a £120,000 mortgage, putting down a £30,000 deposit. The loan-to-value (LTV) of the mortgage is 80%.
The property loses £50,000 in value. It is now worth just £100,000, with a £120,000 loan secured against it (120% LTV).
The landlord pays another £40,000 to remortgage, repaying the equity shortfall (£20,000) and putting down another 20% deposit. The size of the mortgage is now £80,000 (80% LTV).
The risk here is tying up yet more cash in a property that may depreciate further. You might consider this route if you wanted to change the terms of your loan. For instance, you might want to extend the term (see below), or switch from an interest-only to a repayment mortgage.
Ask your lender to extend the term of your loan
Negative equity is a big problem if you are approaching the end of an interest-only mortgage term and need to settle the loan.
Property prices exhibit short-term volatility, but in the long term, trend upwards. Extending your loan term can buy to time to increase the equity in your property or find another way to repay the loan.
One downside of this approach is that you must commit to paying interest for longer. This of course means that you pay more interest overall.
Lenders’ age criteria are also a concern. Most buy-to-let lenders will only lend up to a certain age. If you are at or near retirement, there may be limits to how far you can extend your term.
Be aware, also, that borrowing into retirement has its risks. An individual’s income tends to reduce when they are drawing a pension. It is crucial that you take this into consideration to ensure that costs do not become unmanageable.
Negative equity is only a problem for those who need or wish to refinance or sell. If this is not the case, and you can continue meeting the remortgage payments, doing nothing might be a viable option.
If you are on a repayment mortgage, your equity will increase over time. But as mentioned, most landlords are on interest-only mortgages. Doing nothing may in this case allow the situation to deteriorate, as the loan will get no smaller and the property may not appreciate in value.
Before considering this or any of the other options in this article, be sure to discuss your situation with a relevant financial professional.