Debt to equity ratio is a measure of risk when borrowing on a property. With a mortgage on a house for example it is the total outstanding on the mortgage divided by the current market value of the house times 100%. For example a house worth £200,000 with an £80,000 mortgage on it has a debt to equity ratio of 40%.
The debt to equity ratio on a secured loan is closely linked to its sensitivity to price fluctuations in the housing market. If the housing market is stable or rising, debt to equity will hold or fall. If the house prices fall faster than the mortgage or secured loan is being paid off, the debt to equity ratio will rise. If the debt to equity ratio falls to zero it means there is no debt secured on the property. Conversely, if the debt to equity ratio rises above 100%, we have a situation called negative equity, meaning there is more debt secured on the property than it is worth and the debt becomes only partially secured. This is a dangerous trap as the property cannot be sold to clear the debts if necessary.
In practical terms, if an individual has a mortgage on a house but has negative equity (e.g. he or she has a mortgage for £125,000 but the house is only worth £100,000) he or she cannot sell the house to move either to buy a new house or move into rented accommodation as there is a (£25,000) equity deficit.
At the time of writing, house prices are strong (i.e. they do not look as though they will fall in the near future) so banks are willing to lend to a very high debt to equity ratio on mortgages, subject to income and afford ability, some banks are lending up to 125% of the property value on first time buyer mortgages.
N.b. Individual circumstances vary and these articles only provided for illustrative purposes. I recommend you see a bank assistant or a financial advisor if you need help with your finances.
