What is house equity and why does it matter?
House equity is the difference between the market value of your home and what you still owe on your mortgage. Ideally, it should be a positive number that increases over time. Mortgage payments and home improvements can speed up the process and give you more financial freedom.
The level of equity you own in your property is hugely important, and can influence how much your mortgage costs and whether you can move, for example.
But what is it and how can you work out how much equity you have in your property?
What is house equity?
At its most basic, the equity you have in your property is the amount you own mortgage-free. Effectively, it’s the difference between the value of your property and how much you still owe on your mortgage.
It’s best demonstrated with an example. Let’s say you own a property worth £250,000 and your outstanding mortgage is £150,000. That means you have £100,000 equity in the property.
The idea is that, over time, the level of equity you own in the property will increase as you pay off your mortgage. Similarly, if your property increases in value, so too will the amount of equity you hold.
Why is house equity important?
Equity is important from the moment you first look to buy a property. When you take out a mortgage, it isn’t for the entire sum that you need in order to buy your home ‒ you will also have to put down a house deposit, which is essentially how much equity you hold in the property from the outset.
The size of that deposit will have a big impact on the cost of your mortgage. Lenders offer their products based on a range of loan-to-values (LTVs), which is the size of the mortgage compared to the value of the property.
So taking our example above, if you bought that £250,000 property with a £25,000 deposit (10% of the purchase price), you’d need a mortgage for the remaining £225,000, which works out at 90% LTV.
The higher the LTV, the higher the interest rate charged on the loan, and so the higher your monthly repayment will be. As you build up the equity in your property over time, you can remortgage at lower LTVs, which means lower interest rates and monthly repayments.
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Equity is also important when the time comes to sell your property and move up the housing ladder. That’s because the equity you hold will be the money you have at your disposal to use as a deposit for your next home. This may open up more properties for you to choose from, or mean that you can buy the property with a mortgage at a smaller LTV, making the repayments more affordable.
If you ever find yourself needing money or you want to secure a personal loan, house equity also can be accessed for cash or used as loan collateral.
How do I find out how much equity I have?
To work out how much equity you own in your property, you need to work out the difference between your property’s value and how much you still owe on your mortgage.
You have a few different options when it comes to valuing your home. You could attempt it yourself by researching what similar properties in your area have recently sold for or by getting an estate agent to give you an idea of what it is worth. If you really want an accurate idea of your property’s value, then you could book a formal valuation from a chartered surveyor. Be warned, you will have to pay for this, and the cost can run into the hundreds.
Working out your outstanding mortgage balance is pretty simple. 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 updated balance.
Now you just need to subtract that remaining loan from the value of your property, and you’ll have a figure for how much equity you own.
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Ways to build equity
In theory, you should build up equity in your property as you gradually pay off the mortgage. As the outstanding balance falls, the gap between what you still owe and the value of your property should grow.
In some respects, building equity may be out of your hands; you might do absolutely nothing to change your home, but see its value increase simply because the area in which you live becomes more desirable and property prices rise.
If you want to speed up the process of building equity, you could look into these options:
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), and all it takes to arrange overpayment is a call to your mortgage lender. You could do it by overpaying a small amount each month or paying off a lump sum from your savings.
By overpaying, not only are you building up your equity more quickly but, with interest being calculated on a reduced outstanding balance, you are also reducing the cost of your borrowing and could, potentially, clear your mortgage faster. However, if you would like to do this it’s important to discuss your plans with your lender and ensure repayments are set up as you wish.
You can either use overpayments to reduce future monthly bills or combine them with your typical payment and pay off your mortgage faster.
The other way that your equity can increase is through your home becoming more valuable.
However, you can also invest in certain home improvement work that might increase the value of your property. This could range from something relatively simple like redecorating to more elaborate measures like fitting a new kitchen or bathroom, having an extension or converting the loft into an extra bedroom.
Be warned, there is no guarantee that new home projects will actually increase the value of your home, so it’s likely only something you should consider if you want these improvements for yourself.
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What is negative equity?
If you put down a small deposit of say 5% or 10% on your property, and house prices fall, you may end up in negative equity. This is where you owe more on your mortgage than you would get by selling your home.
If you find yourself in this position, you may struggle to move or remortgage after the initial deal on your mortgage runs out. However, it’s often only temporary and improves when the market recovers and you may pay off more of your mortgage.
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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