When you come to step onto the first rung of the property ladder, there is a lot of information to take on board. If it is your first experience with mortgages, there are probably dozens of financial terms being bandied about that are new to you.
Among these terms, you will almost certainly have heard the phrase ‘home equity’. It is commonly mentioned by mortgage advisors and financial planners as one of the key reasons for owning a property instead of renting one. But what is it? How does it work? Why is it so important?
Join us as we look at the concept of home equity and, in doing so, try to answer some of those questions.
What is home equity?
Simply put, home equity is the current market value of your home, less the amount of money that is still owed to the bank or building society. To look at it another way, home equity is the amount of profit you would make (less costs from your solicitor and/or estate agent) if you were to sell it today for its full market value.
Still unclear? Okay, let us assume that you have your house valued or surveyed and it comes back with a market value of £300,000. Let us also assume that the mortgage you are repaying on the property still has £130,000 outstanding on its balance. The difference – £120,000 is your home equity: it is the amount of your property’s current value that is owned by you, rather than by your bank.
Why is home equity so important?
There are several reasons why home equity is so important. Principal among them is the fact that it is your money – nobody else’s (unless you are paying into a joint mortgage, of course). Equity is an asset. Think of it as a bank account that you are unable to withdraw money from, but the value is always there. Should the need arise, you can sell or remortgage your property (of which more later), and release that equity as the cold, hard cash that you need.
What can affect the value of my home equity?
Since home equity is calculated by subtracting the amount you owe on your mortgage to the amount your property is worth, any change to either of those criteria will affect the value of it, one way or the other. As you pay off the capital amount of your repayment mortgage each month, so the amount of equity in your home will increase. Likewise, should house prices drop, the amount of equity you have will reduce accordingly. While house values and mortgage rates remain static, you can maintain a steady level of equity. During more turbulent times, you can see your amount of equity fluctuate quite a bit.
What is the best way to increase my home equity?
There are only really two ways to achieve this. First, you can whittle away at your mortgage, reducing the amount of capital that you owe to the bank or building society. If you can do so, and if your lender allows it, consider making additional payments each month. Since your interest amount is always paid in full as part of your regular payment, any additional contribution to your mortgage comes straight of the capital, increasing your home equity on a pound-by-pound basis.
The second way is to increase the value of your house. Your first thought might be that this is an area in which you have no control. After all, the whims of the property market are normally well outside of the scope of the average homeowner. And you would be right in that assumption. However, there is another way to increase the value of your property. Certain home improvements can significantly increase your home’s worth. Loft conversions and extensions, for example, often add a lot more than the cost of the work to the property, especially if they result in additional bedrooms.
How can I make use of my home equity without selling my house?
Several lenders have products available that allow you to lend against the equity of your property. In each scenario, you are offering up the existing equity as collateral for the product, with the understanding that, should you fail to maintain payments, you risk losing your home to the lender.
Some of the more common products include equity release, which is normally made available to older homeowners who have largely paid off their full mortgage. In this scenario the money is lent against the equity and released either as a lump sum or a series of smaller payments over a specific term.
Remortgaging is another option. This involves taking out a second mortgage for more than is currently owed and securing it against the property. Once you have paid back the original mortgage, the difference can be released to you as liquid capital.
We hope this short guide helps you to understand both the nature and the importance of building equity in your home. In the long-term, it may be the most important financial decision that you make for your future and is something well worth taking the time to consider in detail.