If you have bought your home in the last two years with a large mortgage, the latest figures from Halifax will not make welcome viewing.  They show that house prices fell by 10.9% between August 2007 and August 2008, which will put more of these homeowners at serious risk of state of negative equity.

What is negative equity?

‘Negative equity’ is a term that has probably not entered the vocabulary of most of the nation’s home-owning public in the last 10 years - so just to recap, this situation occurs when the value of your home is less than the outstanding debt you owe on it. And according to a recent report from credit ratings agency Standard & Poor’s, nearly two million of the country’s homeowners are heading in this direction.

In fact, the research found that 70,000 homeowners in the UK who hold mortgages are already in a state of negative equity following newly-revised house price falls of 10.9% over the past year. It also forecasts that prices will fall by a further 17% (or £30,000) by April 2009, catapulting a further 1.7 million borrowers into negative equity.

Other research shows this trend is already well underway. According to Nationwide Building Society, around three million people who bought a home in the last two years will have watched its value fall to less than they paid for it. Some commentators are even less optimistic still. Roger Bootle at Capital Economics recently revised his house price forecast to a 35% fall in the next three years.

Will I be affected?

Borrowers most likely to suffer from the modern day bout of negative equity are those who took mortgages that were actually designed to put them in negative equity from day one – on the premise that house prices would continue to rise and they would therefore not be in that position for long. Lenders like Northern Rock and Abbey used to offer 125 per cent of the property value to first-time buyers as an initial cash boost for a ‘certain’ return in equity.

Now these and even 100% mortgages are obsolete but the effects of what many experts at the time deemed to be reckless lending, live on. Even borrowers who took high Loan to Values of, say 95% against certain properties, may find they are close to the negative equity edge. For example, those who bought in a new-build block in some city centres where there is an oversupply of such property.

How will negative equity affect me?

But what will actually happen if you find yourself with a property that is worth less than your mortgage? Well, trying to sell your home with negative equity will cause problems as you will still owe the lender even without the house. Depending on your circumstances and the severity of the negative equity, you may be able to transfer the surplus to an unsecured loan – but it’s preferable to stay put if at all possible. Other options are renting out your home – though this will usually result in an increase in the mortgage rate – or extending your current home if it’s just more space you require.

What can I do?

But you don’t have to sit back and wait for the worst – there is clear action you can be taking against negative equity in the mean time.

Start repaying the capital: If you are paying just the interest on your mortgage, switch to a repayment deal as this is the only way you can bring down your debt. Although this means a jump in repayments in addition to rising mortgage rates, perhaps it’s just time to start spend less on other things?

Overpay: If you are already on a repayment mortgage deal, start to overpay every month. Most lenders allow 10% overpayment every year without penalty which will give you a good start. But the more you pay, the faster you can run from negative equity.

Shorten the term of your mortgage: If your lender won’t allow you to make substantial overpayments, shortening the term of your loan will have the same effect.

Care for your property: While you are now unlikely to so much as break even with the cost of a new kitchen or bathroom versus the increased value of your home, a bit of TLC will go a long way to combat falling prices. Keep paintwork fresh, boilers regularly serviced and gardens maintained.

Don't worry: When you are doing all you can about a situation, worrying will only make it worse. Instead, make sure you relax and sleep soundly in the home you are paying for.

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