Wednesday, April 03, 2013

Can Negative Equity be a good thing?

Negative Equity seems to be the bête noire of a certain newspaper - anytime house prices start to drop out pops the headline of "millions in negative equity trap" by itself this wouldn't be a problem; except that for some strange reason politicians and a fair chunk of the population seem to believe what they're saying.

So what is negative equity and why is it such a concern?
Negative equity occurs when the asset secured against a loan is less than the outstanding amount of that loan.  Imagine a house worth £100k with a deposit of £10k. Paying £463 for 26 months and £521 for 274 months. If the value of the house drops below £100k within the first 9 years that would be negative equity as the amount outstanding is greater than the value of the property. Oh no this is a catastrophe! Why?

If the value of the property stays the same the amount paid is the same; if the property increases in value the amount paid is exactly the same; if it decreases the amount paid is exactly the same. The only point in which negative equity becomes a concern is if a) you can't keep up with the mortgage repayments or b) you want to sell the property.

If neither of those two conditions apply than negative equity has zero effect on you. Okay I could say that it limits the ability to remortgage that is paying off the original debt with a new debt negotiated on better terms due to the increase in value. Except if that's the plan the person probably shouldn't have taken out a mortgage in the first place. Anyone in that situation also will be unable to move due to changes in familial circumstances. It can also leave a massive debt should situations shift and a person can't keep up with the repayments; unable to afford a new home and still have a debt burden.

So negative equity can be a bad thing in certain circumstances and is never a good thing in and of itself, but it can also have no effect whatsoever. But that's at the level of the people facing that situation, looking wider and it can be a good thing.

Recall the only reason for going into negative equity is because house prices are falling. Taking that part of the 'problem' alone this is beneficial to the country. During the 80's house prices shot up beyond the previous annual wage multiplier and governments (and again certain newspapers) have conspired to keep these levels static (or even to increase them). House prices go up, more people can't afford them outright and need to take on huge amounts of debt which in turn causes them to desire an increase in their property value perpetuating the cycle. So that's a bad thing?

Unfortunately there's another side to things. High property values encourage more building - because more profit; yet more properties should mean a reduction in prices (supply rising to meet demand) yet it doesn't because supply is constantly outstripping demand due to the type of building combined with the restriction on land. If house prices fall no-one wants to build them and the prices start to rise again; likewise no-one wants to move so only new houses are available restricting the supply. Is there a way out of this? Possibly.

The government has to promote the building of variable blocks of flats and the equivalent over the detached/semi-detached housing estates. Cheap affordable flats allow a step onto the property ladder with a reduced risk of negative equity. With a change in circumstances owners can 'move up' to the larger flats and/or even to a house 'proper'.

With varying sizes of flats on offer being built in the majority this also reduces the social housing burden. The current 'bedroom tax' penalises those in properties deemed larger than their requirements in an effort to encourage them to downsize without their being anywhere they can downsize to. This would solve that problem - a larger family lives in a larger flat; when the family shrinks they can move into a smaller flat in exactly the same area. Hell if done correctly potentially a smaller flat in exactly the same block.

More homes in the same area as an estate equals a greater supply means a reduction in value means negative equity for those already bought (but not a real problem unless particular circumstances are met) creates sustainable housing that will slowly reduce the concept of negative equity. Hell the government could even buy out the debts of those in trouble in return for the property and the family moving into social housing (something the'd probably end up doing anyway). The council ends up with another social house with negative equity (but they won't be selling it).

Flats! More flats; throw money at builders to build flats and no not luxury apartments - just standard decent blocks of flats.


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