Bank warns about negative equity

Recent surveys suggest that one in 10 homes is in negative equity

Negative equity among home owners might have exaggerated the speed with which the UK economy fell into recession, the Bank of England says.

Its Quarterly Bulletin says negative equity can undermine the solvency of lenders as well as depressing borrowing and spending by home owners.

Negative equity affects between 700,000 and 1.1m households, the Bank suggests.

Negative equity arises when the value of a home falls below the value of the loan used to buy it.

But the Bank admits that there is no exact measure of the size of the problem.

Large losses on mortgage loans and associated securities can erode banks' capital positions... and, in extreme cases, their solvency Bank of England

"There are no data which accurately measure the scale of negative equity," the Bank's bulletin points out.

It says that "around 7%-11% of UK owner-occupiers with mortgages were in negative equity in the spring of 2009".

These estimates have been published before, by the Bank itself, the Financial Services Authority and the Council of Mortgage Lenders.

Banks' solvency

The Bank's main concern is about the effect of bad home loans on the stability of the banking system itself.

"Large losses on mortgage loans and associated securities can erode banks' capital positions, affecting both lenders' willingness and ability to lend and, in extreme cases, their solvency," the Bank says.

The bulletin suggests that negative equity may have amplified the speed and scale of the economy's fall into recession during the past year as banks, worried about potential losses, reined in their lending to both individuals and companies.

Its bulletin points out that the amount of money the UK's biggest banks have lent in the form of home loans, is five times the value of their shareholders' capital and reserves, known as Core Tier 1 capital.

And in turn, 40% of all mortgage debt has been packaged up and sold to raise even more loans from the banking system, thus spreading the risk of losses around the banking system far beyond the original lenders.

However the bulletin avoids making any prediction about how much worse negative equity, and its effect on the banking system, will become.

Sudden fall

The Bank points out that the scale of negative equity is similar to that of the early 1990s.

But it has emerged as a problem much more quickly, because of the very sudden fall in house prices from their peak in the middle of 2007 to the first quarter of 2009.

In that time UK house prices fell by about 20%, whereas it took six years for them to fall by 15% between 1989 and 1995.

The Bank acknowledges that negative equity can pose problems for households in that position if they are in financial difficulties.

It makes it harder for them to sell up and move, or to borrow against the value of their homes to pay off other debts, or to finance normal household spending during a period of unemployment.

One consoling feature is that so far the level of mortgage arrears and repossessions has been far lower than that of the early 1990s.

That has been due in part to the very low level of interest rates now prevailing, which have slashed many homeowners' monthly repayments.