Economics Q&A: What is negative equity and does it matter?

Negative equity is a term connected to the fortunes of the housing market and occurs when the value of a property falls below the outstanding debt left to pay on that asset - in other words the market value of a house is less than the existing mortgage debt.

The risk of being in negative equity is greatest for those who have bought a home at the peak of the market just before average prices start to fall. Our chart below tracks prices and shows what has happened in the UK since the property recession started at the end of 2007.

Recent figures from the Bank of England put the scale of negative equity at between four and five per cent of all UK mortgage holders meaning that half a million UK households have mortgage debt outweighing the value of existing assets. And for those in this situation the average level of negative equity is £52,338.

Does negative equity matter?

The simple answer is that for those affected it can matter a lot! For if they have to sell up they face having to fund the gap between what they can sell their property for and meeting the outstanding debt. Effectively many of those in negative equity must hold tight until property prices improve - it impedes their labour mobility.

And to the extent that a sustained fall in property prices hits consumer confidence and contributes to a fall in domestic demand then there can be a negative effect on short run growth. Lower property prices raise the ratio of household debt to wealth and make thousands of property owners vulnerable to fresh economic shocks such as a double-dip recession or an early rise in monetary policy interest rates.

Banks too may be looking with caution at the data on negative equity as a rise in mortgage arrears and defaults connected to falling prices and rising unemployment will hit their bad debts and profits.

But in 2011 there are probably more important things on people’s minds than whether their property is worth more or less than their mortgage. Job security, rising taxes and the difficulties of servicing the high interest rates on unsecured loans figure all much higher on people’s financial agendas. And cheaper house prices (the root cause of negative equity) makes property more affordable and a little easier for first-time buyers to take their first steps on the housing ladder.