Homeowners cope with price falls

Homeowners are far better placed to weather a house price crash than they were in the early 1990s, analysis for the BBC has suggested.

House prices would have to fall by 56% to put the average mortgage borrower in negative equity.

Government figures suggest the average borrower has an outstanding mortgage worth 44% of their property's value.

The analysis was done for the BBC programme the Truth About Property, by housing intelligence monitor Hometrack.

According to Hometrack, the average homeowner has equity worth £167,000.

Few affected

Some 31% of homeowners, most of them in the older generation, have no mortgage on their house at all.

For them, the threat of negative equity is non-existent.

Are you crash proof? The negative equity test - part 1

• You are in negative equity if your outstanding mortgage is worth more than the market value of your house.
• Find out how much you still owe on the mortgage. This should be on your last mortgage statement, or your mortgage lender should be willing to supply an up-to-date figure.

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For the rest, the picture is a bit more complex.

Few economists are predicting property prices will fall far enough to put the average borrower into negative equity.

But some are predicting a 20% fall and that would leave borrowers at risk of negative equity if their mortgage was worth more than 80% of the current value of their home.

One in 20 borrowers - about half a million - are in this position, according to research by the Bank of England.

Many of them have chosen to be in negative equity by opting for mortgages worth 100% or more of the value of their home.

Among that half a million at risk of negative equity, many will be able to sit tight and wait for prices to recover.

Not trapped

It is when borrowers are forced to move - for example because of a change of job, sickness or divorce - that negative equity bites.

Negative equity test - part 2

• Find out the market value of your home. You can get a rough idea, if you don't want to pay for a full valuation or ask an estate agent, by looking at recent sales of similar properties in your street or immediate area.
• The prices paid on completion, as recorded at the Land Registry, are available free of charge on numerous property websites. If the prices date back, you may need to take off a small amount for price falls since the last sale.

Lenders are entitled to insist that borrowers redeem their loans on selling the house on which the mortgage is secured.

In theory, if the mortgage is worth more than the house and the borrower cannot find the money elsewhere, they will be prevented from moving.

But in practice lenders have been prepared to allow borrowers to transfer the mortgage to a new home even if it is worth less - so the fear of being "trapped" is alleviated.

Richer or poorer?

Do price falls damage your wealth?

Negative equity test - part 3

• Divide the outstanding mortgage by the market value of your home and multiply by 100.
• This will express your mortgage as a percentage of the value of your home, also know as your loan-to-value.

The assumption many homeowners make is that even if they are safe from negative equity, house price falls still make them worse off. After all - your home is your biggest asset.

In fact, house price falls do not damage the wealth of most homeowners: they bring benefits.

This is because wealth is not so much what you have, but more what you can buy with it.

And when you change your primary residence, you are not just a seller but also a buyer.

To quote Adam Smith: "Every man is rich or poor according to the degree to which he can afford to enjoy the necessaries, conveniences and amusements of human life."

Just as with any other consumer product, price falls mean you can afford to buy more housing.

Better buy

When prices fall, you will sell your house for less. But unless you rent or leave the country, you also have to buy.

Negative equity test - part 4

• If the market value of your home is £100,000 and the outstanding mortgage is £60,000, then £60,000 divided by £100,000= 60%
• Subtract that number from 100. That tells you how far prices would have to fall, in percentage terms, to put you in negative equity. In this example, they would have to fall by 40%.

If you plan to trade up to a better home, price falls work in your favour.

All else being equal, the price of the place you want to buy will fall by more than the price of the place you are selling.

If you never plan to move again, price falls make no difference to your wealth. You will never realise profits or losses.

It is only if you plan to trade down, to take profits out of property and turn them into cash, that price falls damage your wealth.

If you sell and buy somewhere smaller, you are likely to lose more on the place you are selling than you will save due to the fact that the property you want to buy is cheaper.

There is another effect of falling house prices. Just as rising house prices encourage homeowners to tap the equity in their house by borrowing against the value of their home, falling house prices discourage it.

The Truth About Property is broadcast on Monday, 12 May and Tuesday, 13 May at 2000 on BBC Two.

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