What is home equity?

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.

7 reasons why you should build an emergency fund

An emergency fund can be your last hope in case a financial emergency occurs that you hadn’t planned for. Also known as a rainy-day buffer, an emergency fund is for precisely that, emergencies.

An emergency is anything that affects your ability to earn money. It is not a holiday trip or a birthday party. You must never touch your emergency fund for such situations.

It’s always good practice to save for the unexpected. You never know when misfortune will come knocking on your door. Having something in reserve for such rainy days can protect you from going into unplanned deep debts through emergency loans or other high cost, short term borrowing.

Here’s a detailed list of 7 reasons to build an emergency fund:

1. Job loss

This is perhaps the primary reason for needing an emergency fund. Say your boss fires you for any one of the many reasons in the book or you are made redundant, and you don’t have the financial backing to pay for your expenses. The chances are high that your next move will be to apply for loans.

An emergency fund ensures that this doesn’t happen. You will have a stash of cash that pays for your expenses throughout the time that you’ll not be on regular pay.

A good rule of thumb is that you should have an emergency fund that’s large enough to cover for up to six months’ worth of expenses as you look for another job. The average length of unemployment is most often shorter than this, but it’s helpful to have a buffer – particularly if your skills are specialist and not in super high demand.

2. Car repairs

Cars are a huge investment that require regular maintenance. You never know when your car may break down; maybe you have a damaged tyre or the engine stalls. Whatever the reason is, car repairs can leave a massive dent in your pocket.

It gets worse if your car needs repairs, and you don’t have any cash on hand. You may have to park it until your next payday. However, an emergency fund provides you with financial backing to keep your car in good condition.

3. Home repairs

You cannot count on your insurance to cover all major expenses when it comes to home repairs. This is especially true if you have a high excess. In this case, you may have to come up with the cash to cover the repairs yourself. In addition, insurance most often doesn’t cover things that have just degraded over time due to wear and tear. In this case, the onus is on you to cover the cost of repair.

You may need to part with a lot of money to make major household repairs such as a leaking roof. An emergency fund is just the financial relief that you need for such situations.

4. Bigger, unexpected tax bills

If you are self-employed, this is the one unexpected expense that may prompt you to create an emergency fund. A surprise tax bill isn’t what you want on your desk, especially when struggling with your finances. Taxes usually kick in when your accounts are deficient.

Without a large-enough emergency fund, you may end up financially stressed and possibly end up deep in loans to try and offset some bills. An emergency fund should help you in such situations and even get you out of a financial hurdle, at least until you get your finances in check.

5. Funeral costs

No one can ever predict death. Except maybe with a sick or very old relative. There are, however, instances when you are faced with an unexpected funeral. You’re caught completely unaware and don’t have life insurance to cover up the costs. But even this sometimes takes months before you get the money.

Here’s where an emergency fund can be beneficial. Most funerals cost well over £3,000. An emergency fund can help you to start making necessary preparations and payments for the funeral in the meantime.

6. Unanticipated travels

Maybe a family member passes away, and you are forced to buy an exorbitant-priced last-minute plane ticket to get to the funeral. An emergency fund will protect such expenses from lingering on your credit bill, and racking up interest. You can buy a plane ticket quickly and any other bills in preparation for such travels.

7. Emergency pet care

This one applies more to homeowners with pets. Owning pets comes with a few regular expenses. But would you be prepared to fork out thousands of cash if your dog or cat needed surgery? Major pet operations can leave a substantial financial debt, especially if the payment is out-of-pocket.

An emergency fund can cover these costs and not leave your accounts financially strained.

Key takeaway

Life is full of surprises. It doesn’t always work out as planned. The question you must, therefore, ask yourself is; could you cope if you were faced with an emergency? Realistically, everyone has bills that need paying and other things that take priority. But either way, it’s still good financial practice to have some cash stacked away somewhere for rainy days.