Trapped in your own home

The current stagnation in the housing market has created severe problems for the economy in general and for individual homeowners in particular. Perhaps the worst of these has been the considerable social misery caused by the phenomenon of negative equity, which emerged in 1989. A combination of falling nominal house prices and high loan-to-value ratios resulted in the unprecedented situation of many homes being worth less than their mortgages.The long-held belief that house values could not fall had been broken and the spectre of negative equity was born.

The peak was reached in early 1993 at the bottom of the housing slump. By this time about 1.8 million households had fallen into the equity trap. Most were in the south of England, with over half of those affected living in London and the South-east.

Numbers have gradually fallen back from the 1993 peak. Modest gains in house prices in the South-east have released about 100,000 households from negative equity in the past six months. Despite these falls, Bradford & Bingley's economic unit estimates over 1.1 million households are still affected, with an average shortfall of about pounds 4,500.

This is only the tip of the iceberg. A substantial group of households have seen nominal house price falls wipe out most of their equity. These are not included in the negative equity calculations, although their plight is also grave.

Given the considerable costs of buying one house and selling another, anything less than pounds 6,000 in housing equity is likely to lock homeowners into their current properties. Consequently, there are a vast number of people who, while not in negative equity, have insufficient equity to move.Our calculations suggest this covers a further 1.5 million households across the country.

These figures imply that there are over 2.5 million households that cannot afford to move house. Equity-trapped families represent about one in four of all mortgaged households and one in six of all owner-occupiers. As well as removing a large number of potential sellers from the housing market, this has also acted as a restraint on the mobility of the labour force. But the big impact has been the severe social misery negative equity has caused many homeowners by turning their castles into prisons. The main burden has tended to fall on the young. Almost 75 per cent of negative equity households were first-time buyers when they bought their property and this has resulted in a severe psychological impact on a generation of home owners.

Building societies have taken a sympathetic approach. Practical solutions have been introduced enabling families to move house and take their negative equity to a new property. Over the past couple of years Bradford & Bingley has helped many of its negative equity borrowers move home in this way.

Although such schemes provide some relief, the big hope for households suffering from negative equity is a rise in house prices. Unfortunately a sustained recovery in housing market confidence has failed to materialise. Despite the continuing UK economic recovery, further evidence of gloom on the home front appears to be emerging almost daily.

House prices in June fell for the fourth consecutive month and are 1.9 per cent lower than last year, according to the Halifax House Price Index. Turnover is also weak, with seasonally adjusted property transactions in May only 98,000, the lowest level for two years.

Despite this gloom, home ownership remains an attractive long-term proposition for most of the population. House prices are at an all-time low relative to earnings, and as incomes start to rise, the market and prices will recover. Although the days of large speculative housing gains are long gone, people buying for nesting rather than investing reasons will still be attracted to owner occupation.

The problem is managing the transition from the current slump to a stable housing recovery. A combination of job insecurity, high levels of personal sector debt and declining government assistance all continue to knock confidence in home ownership. The change from a high to a low-inflation economy has also hit home owners hard. Although ultimately a stable economy with low interest rates will help the housing market, government help is needed to smooth this transition.

It is not desperate measures that are called for. Indeed, it is important any government action is not simply a short-term, knee-jerk reaction, which would only result in temporary distortions to the market, such as the bunching of transactions at the end of the nine-month stamp duty holiday in August 1992.

Proposals have been suggested for direct government assistance to home owners with negative equity.While such a subsidy may have strong emotional appeal it would invite fraud, as well as being extremely difficult and expensive for the Government to administer. It would also be unfair to owners who have initially saved hard for a deposit or have since repaid part of their mortgage to free themselves from negative equity.

Bradford & Bingley believes the biggest boost for most households in negative equity would be a sustained improvement in the housing market and a rise in prices. Relatively small increases in house prices would free most victims. Generally speaking, a 1 per cent rise in prices releases about 100,000 households from the equity trap.

While nobody wants to see a return to the boom-and-bust scenario of the1980s, modest nominal house price rises would be helpful. Indeed, with the market desperately weak, there is no prospect of it overheating in the near future.

Government attitudes to owner-occupation have been largely negative over the past few years and a more positive stance in support of the housing market would be a significent help.

Specific measures aimed at first-time buyers would be particularly welcome. These would help to boost activity and get the housing market back onto an even keel.

One option would be a repackaged version of mortgage interest tax relief for the first-time buyers in the first few years of the loan. This would aid first-time buyers through the difficult early years of purchase. This repackaged MITR could also be linked to a savings-related home-ownership scheme for first-time buyers. An incentive to save, linked to a below- market mortgage rate, would create greater levels of personal equity in the property, providing greater stability in the housing market as a whole.

Well-targeted government action would help restore confidence to the housing market and the personal sector in general.

In the current market conditions, negative equity is unlikely to disappear quickly without some positive action. Its dark cloud will continue to cast a shadow over the housing market and the economy. The main problem, however, has been the social misery it has heaped on millions of households. That is why for many disillusioned home owners the spectre of negative equity cannot be exorcised quickly enough.

The author is Head of Strategy at Bradford & Bingley Building Society.