House Equity: What Is It and Why Does It Matter?
House equity is the difference between the market value of your home and the amount you owe on your mortgage and secured loans. So it’s how much you own of your property. Ideally, your home equity will increase over time as you make mortgage payments and if the value of your home rises.
House equity, or home equity as it is sometimes also known, is hugely important to home buyers. In particular, the amount of home equity you have can play a big role in determining how much your mortgage costs and whether you might be able to move.
Read on to find out exactly what house equity is and how to calculate the equity in your house.
What is home equity?
The equity you have in your property is essentially the amount of your home that you own outright. If you have a mortgage, house equity is the difference between the value of your property and the amount that you still owe on your mortgage, along with any outstanding secured loans.
So if you’re buying a property worth £250,000 and your outstanding mortgage is £150,000, with no secured loans, you have £100,000 in house equity.
It follows that if your property increases in value, so too will the amount of equity you hold. Similarly, if you have a repayment mortgage, the idea is that, over time, the level of equity you own in your property will increase as you pay off your mortgage. The same won’t apply if you simply make the monthly repayments on an interest-only mortgage, where you only pay back the interest on your mortgage each month but then have to repay the original loan amount at the end of your mortgage term.
Once you have paid off your mortgage entirely, and if you have no outstanding secured loans, then you’ll own 100% of the equity in your home.
Why is house equity important?
Equity is important from the moment you first look to buy a property and continues to have a vital role to play as you look to progress up the property ladder.
Getting a mortgage
When you take out a mortgage for the first time, you usually have to put down a deposit; your deposit amount is essentially how much equity you hold in the property at the outset.
Crucially, the size of that deposit can also affect the cost of your mortgage. That’s because the mortgage rate you’re offered will be influenced by your loan-to-value, or LTV – this is the size of the mortgage you need compared to the value of the property.
So if you want to buy a home worth £250,000 and have a £25,000 deposit, you have accounted for 10% of the purchase price, but will need a 90% LTV mortgage to cover the remaining £225,000.
Generally, the higher the LTV, the higher the interest rate you can expect to pay. Or looking at it another way, the larger your deposit, and the bigger the equity stake you take in your property at the start, the better your chance of being offered a lower mortgage interest rate.
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Remortgaging and moving
The good news is that as the equity in your property builds, you might be able to remortgage at a lower LTV. In turn, this could mean lower interest rates and monthly repayments.
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Similarly, equity is important if you want to move home. That’s because the equity you hold in your current property will be the money you have at your disposal to use as a deposit for your next home.
If your house equity has increased, this may open up more properties for you to choose from, or mean that you can buy the property with a mortgage at a lower LTV, potentially making the repayments more affordable.
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How do I calculate the equity in my house?
To calculate how much equity you have in your home, you need to work out the difference between your property’s value and how much you owe on your mortgage and any secured loans you might have.
When it comes to valuing your home, you could research the recent sold prices of similar properties in your area or arrange for an estate agent to give you a valuation. If you want a more accurate indication of your property’s value, you could pay for a formal house valuation from a chartered surveyor.
Finding out your outstanding mortgage balance should be relatively straightforward. Each year your lender will send you an annual statement breaking down how much you paid off over the past 12 months and what you still owe. You can also call your lender to get an up-to-date balance. Recent statements or a call to your lender will also reveal how much you owe on any secured loans.
To calculate your home equity, you subtract your outstanding mortgage and secured loan balances from the valuation that you have for your property.
How to build equity in your house
All things being equal, you should build up equity in your property as you gradually pay off your mortgage. And if the value of your property rises, perhaps simply because the area in which you live becomes more desirable and house prices rise, your house equity will increase too.
If you’re impatient for your home equity to increase, and your finances allow it, you might consider:
Overpaying on your mortgage
Your usual mortgage payments will reduce what you owe and so should steadily increase your equity. However, most mortgages allow you to overpay by up to 10% of your outstanding balance each year before you start having to pay early repayment charges (ERCs). You can make overpayments by overpaying a small amount each month or by a one-off lump sum overpayment. It’s a good idea to speak to your lender directly about this as any tiny amount over the allowance will incur early repayment charges. Your lender can tell you exactly what your allowance is to the penny.
Making improvements to your home
Carrying out certain home improvements has the potential to increase the value of your property, and so could also accelerate the rate at which you build equity in your home. These could range from something relatively simple like redecorating to more extensive work, such as fitting a new kitchen or bathroom, building an extension or converting the loft.
But as there is no guarantee that such projects will increase the value of your home, it’s always worth considering if you want these improvements for yourself.
How to use equity in your house
There are various ways the equity built up in your home can be put to use. These might include:
To buy a better house
The more equity you have, the larger the deposit you effectively have to put down on your next property, potentially allowing you to progress further up the property ladder.
To access as cash
If you’re willing to downsize and buy a cheaper property than the one you’re selling, you can access the equity you’ve built up as cash for you to spend as you like. Alternatively, if you don’t want to move, you might be able to free up funds by remortgaging to release equity and switching to a new mortgage.
As security for a loan
If you need to borrow a larger amount of money, you might be able to take out a secured loan against your home equity. Sometimes these are referred to as a homeowner loan or as a second charge mortgage if you already have a mortgage on your property. These options may be worth exploring if you’re finding it difficult to get a personal loan, although your property is at risk if you don’t keep up with repayments.
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To help fund your retirement
Once you reach age 55, you might want to unlock the equity you have in your home using equity release. A scheme such as a lifetime mortgage won’t be suitable for everyone, but if used correctly can provide a regular income or access to lump sums to help support your finances in later years.
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What is negative equity?
Negative equity is when you owe more on your mortgage and loans secured against your property than you would get by selling your home. An example of when this could happen is if you put down a small deposit of say 5% or 10% on your property, and house prices fall.
If you find yourself in negative equity, you may struggle to move or remortgage when the initial deal on your mortgage runs out. Waiting for house prices to increase, making home improvements and overpaying on your mortgage might all help you to escape negative equity.
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John Fitzsimons has been writing about finance since 2007. He is the former editor of Mortgage Solutions and loveMONEY and his work has appeared in The Sunday Times, The Mirror, The Sun and Forbes. Read more
Tim draws on 20 years’ experience at Moneyfacts, Virgin Money and Future to pen articles that always put consumers’ interests first. He has particular expertise in mortgages, pensions and savings. Read more