If you are a new homeowner or if you are planning to buy a house, you have probably heard of home equity. You might even have heard that one of the main benefits of owning a home is the ability to build equity. Yet, much confusion still persists regarding the term ‘home equity’. How does it work, and why does it matter?
Let’s explore what home equity is, how to build or increase it, and how it can used.
Home equity is the difference between your house’s current market value and the money that you still owe on it.
Let’s say, for instance, that your home has a market value of £250,000, and your remaining mortgage balance is £150,000. This means that you’ve got £100,000 in home equity. If you decide to sell your home, you could pocket a cool £100,000 (ignoring estate agents’ fees and legal costs).
It is important to note that home equity can change (both up and down) depending on the current market and your mortgage terms.
There are two main ways in which the equity in your home can increase.
The first is paying off some or all of your mortgage debt. Essentially, if you have a repayment mortgage, the equity in your home increases every month as you make mortgage payments. It increases by the amount that you pay off the capital on your mortgage. You can chip away at your capital much faster – and build equity at a faster rate – by either making a lump-sum payment or making overpayments every month. However, it’s best to check your lender’s terms before doing so.
The second strategy involves your home increasing in value. This can happen naturally as a result of a rise in house prices in your area.
However, you can also take action to increase your home’s value by making improvements. For instance, you might add an extension or renovate the kitchen and bathrooms. However, be cautious as not all improvements will increase the value of your home.
This is where things get interesting. Lenders offer financial products that allow you to borrow against your home equity.
There are many reasons why you might want to do this. For example, you might want to use the cash to fund home improvements (which could actually increase your home’s value and, thus, its equity). You might choose to use the money to fund retirement or to cover unexpected costs such as medical expenses.
The two main options for accessing the equity in your home are:
Before accessing either of these financial options, it might be useful to first analyse your personal circumstances and determine how either one will affect your current as well as your future financial well being. It might also be wise to shop around and compare different providers’ rates and offers.
As a new homeowner or a prospective buyer, home equity can, in time, turn out to be one of your greatest financial assets and can make up a significant part of your net worth. It can also serve as protection against unexpected expenses. The key is to start building it as soon as possible.