Negative equity is a feature of the property market that often strikes fear into homeowners.
Financial turbulence in the late 1980s, early 1990s and in 2007-08 left millions of people living in homes that were worth less than the mortgage still outstanding on them. That has a paralysing effect on homeowners, leaving them unable to sell up or to clear their debt.
Removing risk of crash
However, major new research by academics has suggested that new models of investment could remove the risk of a crash in house prices and eliminate negative equity for good.
The research has been carried out by Professor Radu Tunaru of Kent Business School at the University of Kent, Nobel Prize winner Professor Robert Shiller of Yale University and Professor Frank Fabozzi of EDHEC Business School in France.
Published in the Journal of Derivatives, the report – entitled Evolution of Real Estate Derivatives and Their Pricing – suggest that the financial sector’s adoption of newly created products would allow banks to “hedge” against house prices falling.
Essentially a homeowner would link their property to a financial fund when agreeing on a mortgage. That product would be used strategically in the market or “hedged” to offer the risk of adverse movement.
Fund acts as insurance policy
If house prices then fall, leaving the homeowner in negative equity, they can make a claim on the financial fund to make up the difference.
However, if house prices rise, the fund would gain with no benefit to the homeowner because the fund is acting as an insurance policy.
The researchers consider this risk-averse strategy a positive option for property owners, the majority of whom buy a home to live in.
Provide more stability
Professor Tunaru said: “The research makes it clear that real estate derivatives could be a key product to provide more stability to real estate markets, potentially helping avoid huge economic shocks caused by any future house price crash, similar to that which occurred during the Great Recession.
“This could help remove a lot of uncertainty when purchasing a house and avoid the risk of negative equity, which is often a major concern for homeowners.”