Negative equity

united4ever

A question about interest rates.

I thought that when the economy is overheating the government raised interest rates to encourage people to reduce consumption and save more. Conversely, when there is a recession I thought interest rates were lowered to encoursge spending/consumption and stimulate the economy.

Why then are interest rates high at the time of a house price crash? Isn't this generally the same time as a recession when consumption is very low and therefore an incentive is required for people to spend money.

Forgive my basic understanding of economics, just would like to understand it better.

meanmachine_2

Put simply interest rates are used to control inflation.

If inflation is rising because of an increase in commodity costs such as oil (due to scarcity), then IRs must remain high.

America's in that tricky position right now. If they were to start cutting IRs then the dollar would plunge (as it is doing) and inflation soars (because of rising import prices).

It's a high wire act. Plus there are other issues such as lag. IRs have a lag effect, so we won't actually see the impact on a rate rise on, say, the property market, for another 6-12 months.

Alan_M_2

EdInvestor wrote:

Most people who got badly affected by negative equity in the early 1990s were people who had a separate problem which meant they really needed to sell their home - eg, lost job, relationship broke down, divorce, serious illness.

But later the lenders realised the problem and got more flexible, allowing people to transfer and increase their old mortgage to take account of the price drop and move.

Also, the idea of BTL was born, as people let out their house in desperation because they were forced to move and couldn't sell.Later the law on letting was improved and this blossomed into the new market we see today.

Nowadays the market is much more flexible, and people have much more equity in the homes to start with, so the likelihood of negative equity becoming a problem again is low.

Actually that's a generalisation, in my particular case in the early 90's along with thousands of people, the interest rates increased so much that my mortgage payments were more than my gross income.

Will the same occur again?

Well interest rates won't hit 15% (which they were actually only at for about 4 hours then they were drawn back down to 12% at close of business same day).

However, my mortgage at the time was £63,000 (my loan was 4x income and I had put down 12.5% deposit) and the repayments peaked at over £1,000 per month plus endowments. That was more than I earn't, never mind living expenses, travelling to work, my choice was, go bankrupt, or hand the keys back and go find somewhere to rent, then pay off the difference between what I owed and what the house was auctioned off for. In hindsight I should have gone bankrupt, but morally I didn't want to do that I the time.

Well it's unlikely that interest rates will rise to that level again, but then they really don't need to as the loans are now so much larger that a quarter percente rise now has the same monetary effect as a full point rise did 15 years ago.

With regard to negative equity, well, if you can manage to keep the pyments going and ride it out it isn't the end of the world, but also remember you won't be able to get credit cards, vehicle finance, personal loans as you'll be in debt, this is often overlooked.

EdInvestor

united4ever wrote:

A question about interest rates.I thought that when the economy is overheating the government raised interest rates to encourage people to reduce consumption and save more. Conversely, when there is a recession I thought interest rates were lowered to encoursge spending/consumption and stimulate the economy.

Indeed so, this is what they do now.

Why then are interest rates high at the time of a house price crash?

In the old days, crashes were caused by high interest rates.As above, if there hadn't been high interest rates, there wouldn't have been crashes. :rolleyes:

Isn't this generally the same time as a recession when consumption is very low and therefore an incentive is required for people to spend money..

Yep

Snow_Dog

EdInvestor wrote:

Indeed so, this is what they do now.



In the old days, crashes were caused by high interest rates.As above, if there hadn't been high interest rates, there wouldn't have been crashes. :rolleyes:



Yep

Are you serious? Is it really that easy? Quick, someone tell the MPC and the Fed. No more crashes if you dont raise the IRs. Hurrah.:D

Spendless

Hi

I bought end of 94 and my house was in neg equity within a year. It was not a problem until I met my now husband and wished to move areas to be with him. I couldn't afford to do so, as I had no money with which to pay off the neg equity. We tried to rent my house out, but couldn't find a tenant.

In the end my husband moved to my house instead, and we sold his property. We married and had our eldest and now the house was too small for the 3 of us. It was also in an area where I did not wish to bring up a child. This time we were fortunate enough to find someone to rent my house and we bought a bigger house. A couple of years later the tenants moved out and the house prices had soared, we were able to sell my house at a profit.

HTH

silvercar

the problems with negative equity start as soon as your mortgage deal runs out. Try looking around for a new deal and the majority of lenders will only lend upto 100% of your house value (some a lot less). There will be lenders who will do more than 100% but not on the good deals that are available for lower percentages.

Say you got a fixed rate of under 5% for two years at 100% loan to value. Then prices fall and at the same time, its time to remortgage. May be your current lender will only lend you 6%, there may be 5- 5.5% deals available but only upto 100% or 95% loan to value. If your house has dropped in value, you'll be stuck on 6%!

meanmachine_2

Snow_Dog wrote:

Are you serious? Is it really that easy? Quick, someone tell the MPC and the Fed. No more crashes if you dont raise the IRs. Hurrah.:D

People like EdInvestor should come with a health warning.

I wish people would take responsibility for their own actions rather than lazily assuming central banks will help them out.

"My house can't possibly fall in value because the government will just lower interest rates".

What have house prices got to do with interest rates?

The BoE didn't have the power or remit to stop the boom, they won't be able to stop a bust either.

The best course of action is to not borrow stupid amounts of money and to put down a big deposit.

PoorDave

meanmachine wrote:

The best course of action is to not borrow stupid amounts of money and to put down a big deposit.

Good advice

Edited to say that this statement by MM could be a stock response on this board to so many questions! As a first piece of advice to anyone wishing to purchase a house of their own, it sits quite nicely.

sm9ai

lynzpower wrote:

but I presume lots of people, particularly those in significant unsecured ( or worse secured :eek: debt) would not be able to service those, and voila they need to sell up- except they cant if they are in neg equity.

Do I have that right?

Pretty much and if you can't sell then the bank will auction your house for you.