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Buy To Let Mortgages Face Negative Equity

May 15, 2008
Tens of thousands of property owners may be at risk of negative equity this year if the prediction of falling house prices comes true. Leading organizations are estimating that property prices will fall by about five percent during the year which leaves almost no margin for error for the thousands of would-be property investors who bought properties with 95% buy-to-let mortgages during the past few years.

The buy-to-let property boom of the early 2000s has made hundreds of thousands of investors asset rich due to short term increases on property prices. Unfortunately for many new investors who jumped on the bandwagon at the tail end of the boom, thousands of property owners now face ruin. This is because lenders were still offering buy-to-let mortgages with high loan to value ratios to amateur investors despite the fact the property market was cooling.

Securing buy-to-let mortgages against properties with high loan to value ratios was less of a risk five years ago. This is because property prices were skyrocketing, meaning that the margin between the value of the mortgage and the value of the property would quickly grow due to natural appreciation. This feature of the property market has since disappeared. Lenders of buy-to-let mortgages, however, continued to approve high loan to value loans, such as 95% mortgages, despite the fact that property prices were no longer growing at high rates.

This has lead to a situation in which thousands of property investors have purchased properties within the past year or two with 95% buy-to-let mortgages. Instead of their properties increasing in value, as they had done during the preceding years, they have either remained stagnant or decreased. This means that the 5% equity held in the properties on the date of purchase either remains the same or has eroded. If the value of a property falls below the outstanding balance of a mortgage then the property goes into negative equity.

This is the situation faced by many property owners this year as house prices begin to decline as part of a wider correction in the world property market. Prices had been pushed to record levels during the past few years due to easy access to credit and low interest rates. Buy-to-let investing also became a fad and it seemed that everyone was buying investment property. Although the property market is not in freefall it is safe to say that the bubble that has built up over the past few years has finally burst.

Some investment property owners have even exaggerated their problems by funding the 5% deposit required with further borrowings from credit cards and personal loans. This has exacerbated the problem as the properties they own are effectively financed to 100% of their value - and this value may be declining. Therefore, even if they are able to sell their properties and redeem their buy-to-let mortgages they may be stuck with thousands of pounds worth of unsecured borrowings to pay off.

Only time will tell what happens to these borrowers over the next few years. The telling factors will be interest rates and property values. If interest rates climb too high then the buy-to-let mortgages and other borrowings may become unaffordable. If property prices decline then many thousands of would-be property millionaires will fall into negative equity and will not be able to pay off the balance of their buy-to-let mortgages - even if they are lucky enough to sell their properties.
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