The buy-to-let we bought in 2007 is still in negative equity: How do we get out? DAVID HOLLINGWORTH replies

My wife and I purchased a rental property in 2007 and it turned out to be the worst financial decision of our lives.

We bought it for £155,000 with a deposit of £35,000, leaving us with a mortgage of £120,000. But the recession hit soon after and its value plummeted to £75,000.

Initially the mortgage was interest only, but three years ago we switched to a repayment mortgage to try to reduce the debt. We have never missed a payment.

This property continues to drain all of our finances and I cannot express to you the negative impact this has had on our lives. This gave us many sleepless nights.

The mortgage rate has recently increased to 8.74 per cent (£949.07 per month), which is no longer sustainable for us. As we are in negative equity, we cannot switch to another bank.

We also pay around £150 in management and agent fees, and the rent we earn on the property is £500 per month.

We considered returning the keys to the bank, but since we still have a mortgage on the house we live in, we are concerned about the impact on our credit report.

This mortgage has an outstanding balance of £94,000 and is currently at a rate of 1.94 per cent (£702.84 per month). The deal ends in July. This is a loan-to-value ratio of 25 percent.

Should we refinance our own home to try to reduce the LTV of the other nightmare mortgage? Could we refund small lump sums to try to resolve the problem?

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David Hollingworth responds: Negative equity is a phrase that will scare any homeowner. This is when a fall in house prices means a property is worth less than the amount of the remaining mortgage.

Real estate prices go up and down all the time, and negative equity often doesn’t cause an immediate problem. When the mortgage remains affordable and the homeowner is happy to continue living in the home, there is no need to crystallize a loss.

But if that changes and there is a need or desire to sell, it may mean having to find additional funds to cover the outstanding debt.

It can also mean homeowners struggle to get a new mortgage at a reasonable rate, as you’ve found.

The sharp drop in prices following the financial crisis has clearly affected the options available to you. According to the National House Price Index, average prices in Northern Ireland, where you live, peaked in 2007, but fell sharply in 2008 and beyond.

Average prices have improved over time, so knowing the current market value of your property will be essential. Asking your agent and others for advice will help you get a clear idea.

It’s a good idea to consider position in the round, and returning the keys will not rid you of any unpaid liability. It is therefore important to think about the options available to you, not only for the investment property in isolation, but also for your main residence.

> Real cost mortgage calculator: check how much a new fixed rate would cost

Trapped: as our reader is in negative equity, this means that he cannot change banks and is therefore at the mercy of the interest rates offered by his current bank.

Should the rental property be sold?

Above all, you have met your mortgage payments even if the rental income does not cover your costs.

It is very common for the purchase to allow investors to take out the mortgage on an interest-only basis, preferring to pay it off when the property is sold.

Your decision wasn’t unusual, but by not reducing the debt over time, it means the sharp drop in value has left you even more underwater.

It appears that your rental mortgage is a standard variable rate. The fact that you always expect to have negative equity means you can’t shop the entire market and get a rate that makes your payments more manageable.

However, you can discuss with your lender the options available to existing customers. Many lenders offer alternatives to their existing customers, even when the mortgage exceeds the value of the property.

They may be able to offer a slightly lower rate, although this may mean having to accept an early repayment fee, so make sure this fits into your plans.

Anyone experiencing difficulty meeting their mortgage payments should speak to their lender, as they may be able to offer alternative options to help them cope with the situation.

> What’s next for mortgage rates and should you lock them in for two or five years?

Real estate price crash: Our reader purchased the rental property just before the 2008 financial crisis, during which the property value halved.

Can their main residence compensate for rental losses?

There are a few moving parts, but now is the time to consider your overall situation, including your home’s mortgage.

You had a low fixed rate, but it is coming to an end and will increase due to the higher rates currently in effect.

Where the loan-to-value ratio is very high, the situation is very different in the case of your primary residence where you have 75 percent equity.

This will give you access to the best rates in the market, but it also means you have equity that you may be able to free up, which could improve your overall financial situation.

If your income can allow you to borrow more for your primary residence, this could allow you to borrow more, whether from the existing lender or on the open market.

If you then decide to sell the buy-to-let, the money freed up could allow you to cover any shortfall if the sale brings in less than the outstanding mortgage.

Alternatively, you could decide to use the freed-up money to pay off part of the rental balance, which could open up access to better buy-to-let rates.

Buy-to-let lenders will still need to ensure that the rental income will cover the mortgage interest by a sufficiently large margin, so you will need advice to find the right balance.

The latter option would leave you with the same overall loan, but could help reduce total monthly expenses if you want to keep the property.

Selling the property will crystallize any loss, but could give you greater peace of mind, if you are able to manage the additional borrowing needed to make up the shortfall.