16 May 2022
A Guide To Home Equity
You may have caught adverts on daytime TV talking about releasing equity from your home, but what is equity and what exactly does releasing it mean? If you’re not sure, we’ve put together this guide to help you understand everything you need to know about home equity.
What Does Home Equity Mean?
Equity is best understood as the amount of the house you own outright. For example, if your house is worth £300,000 and you’ve paid a total of £100,000 towards your house via your deposit and monthly payments, your equity amount is £100,000.
House Deposits and Equity
When you purchase a property and get a mortgage, you will be required to save up and pay a deposit of usually at least 10%. However, there are currently some 5% deposit deals being offered by lenders, this is due to a scheme backed by the government to help first time buyers get on the property ladder.
The scheme is currently intended as a temporary offer in response to the pandemic’s effect on the housing market and was introduced in April 2021, with it being due to end December 2022 (though the government will be reviewing whether to extend this further closer to the end date).
The deposit you pay will go towards the amount of the house you own outright from the start, aka your equity. So the bigger the deposit, the more equity you will have in your home from the get go.
Loan to Value
Another term that may come up is “Loan-to-value” or LTV. This is a ratio that lenders use to determine how much of a risk they are taking by offering a loan to someone. The 5% scheme is also known as the 95% mortgage, because 95% of the purchase of the home is thanks to the mortgage doing the heavy lifting.
Having a bigger deposit will reduce this percentage ratio, making your mortgage application look better as well as giving you more equity, so it’s helpful to know what your LTV ratio is.
For an explanation of more terms, click here.
What is Negative Equity?
In simple terms, negative equity happens when a property is worth less than the mortgage you originally took out on it, but you are still paying that mortgage back.
How Does Negative Equity Happen?
This can happen if there is a sudden change in the value of property and house prices decrease, though this may sound unlikely, it’s not impossible. This is also more likely to happen depending on certain mortgages, or if you don’t have the right mortgage for your circumstances.
For example, interest only mortgages run the risk of negative equity because you are only paying the interest on a mortgage every month, with the idea that you pay it off in full at the end. This might work for some people’s circumstances, but you won’t be building up any equity for the entire term of the mortgage.
Though being given the option of a 5% deposit is a positive thing and will really help people who have no other option, a lower deposit does also risk falling into negative equity as it will take more time and money to pay off the rest of the house.
In the time it takes to build up the equity as you pay off the mortgage, house values could drop while you’re still at a low percentage of the mortgage being paid off. This will leave you paying off a bigger mortgage than you would necessarily need to.
With low deposits there is also the fact that you’ll be paying a higher amount per month. You also have to factor in the interest rate on top of the monthly payments. The longer you’re paying the mortgages, the more interest will accumulate. Although a fixed rate mortgage can lock in the interest for a while to prevent it from rising, there’s a slight risk of you missing out on paying less if interest rates fall. Despite this, fixed rates are still one of the most popular choices.
Speak to our online mortgage advisors for more information on what type of mortgage is right for you.
How to Increase Equity
For most people, besides gaining instant equity from your deposit, increasing the remaining equity your house has is simply a matter of time, as you will build up a little bit of it with every month you pay off your mortgage.
If you have some surplus money and you don’t want to wait that long, you may be able to make some early repayments. Depending on your mortgage type there may or may not be a fee.
How Releasing Equity Works
Releasing equity gives you the ability to access the money value in cash (aka the equity) that you have built up in your home - without having to move home or downsize to get it.
Equity release deals are for people of 55 and over, who have paid off most or all of their mortgage and it is a way to gain cash quickly. This cash can then be used for things like home renovations which could in turn increase the total value of the house.
The two main options for equity release are a lifetime mortgage or a home reversion plan. With a lifetime mortgage you borrow a portion of your home’s value at either a fixed or capped interest rate. You have the option to take money as a lump sum or in smaller instalments as and when needed. A home reversion plan raises money by selling part of or all of your house whilst still living there.
For most of these mortgage plans, you do not need to pay anything until you pass away or move into long term care. Some also have a no negative equity guarantee for extra protection.
Equity release will affect the inheritance you leave to your family, so talk to an expert about your options.
More Mortgage Advice
If you need advice and want to know more about remortgaging or need help finding any other kind of mortgage, speak to one of our online advisors today. We can find a mortgage to suit your circumstances, so contact us on 03300 58 60 58 or email ask@mortgages.online, you can also start the process straight away via our online forms.
