What is equity?
Put simply, equity is the value of an asset minus anything you currently owe on it. It is the amount you would have left over if you sold the asset and paid off any debt on it.
What is house equity?
Equity in a house, therefore, is the value of your property, minus any mortgage or loan you have not yet paid off. It is the amount of your own wealth that is currently tied up in the house.
For example, if you own a house worth £200,000 but still currently owe £50,000 to the mortgage lender, then the house represents £150,000 of equity.
Equity in a property will build as you pay off your mortgage, but may also fluctuate depending on the property market. There is no guarantee that your property will increase in value. When someone has paid more into a property than it is worth, it’s called ‘negative equity’.
How to use equity in your house
There are a number of ways you can access your home equity. The simplest way is to sell your house. It’s likely that you won’t live in the same house for the rest of your life, so you could sell your current home and use the equity to buy your next one. Just remember that equity is the sum after you’ve deducted anything you still owe on your mortgage.
This is what most people do when they’ve owned a home before, and they’re buying another. If you’ve paid off a large chunk of your mortgage, your equity can be used as a sizeable deposit for your next property. Or if you downsize to a smaller house, you may be able to pay for your new home outright and live mortgage free.
However, you may not want to sell your home. Many people are equity-rich, but cash poor. Luckily, if all of your savings are tied up in your home, there are now ways to use that money without selling your property. This is known as equity release.
There are three main equity release schemes:
A home equity loan
A lifetime mortgage
A home reversion scheme
Home equity loans
You could take out a home equity loan – which is essentially a second mortgage. Although you’ll be decreasing the amount of equity you have in your property by increasing the amount you owe on it, it may well be a good way of increasing wealth in the long run. The rates on a home equity loan are often much better than you’d get for a personal loan.
Home equity loans are a good choice for people who have built up considerable equity in their property, and want access to a larger sum of money (usually between £15,000-£100,000). Often they are used for home improvements and refurbishment, because they add value to your property.
You could also use it to consolidate other debts, accessing a better rate.
These loans work the same way as your initial mortgage – they can be fixed fee for a certain amount of time and then can revert to a Standard Variable Rate (SVR), so it’s worth shopping around as you would for a mortgage when the term ends.
Remember that if you cannot afford to pay back the loan, your property will be at risk.
A lifetime mortgage will allow you to fund your retirement. It enables you to withdraw equity from the house without selling it, so you can fund your retirement without having to move to a smaller home.
Interest builds up on the new loan, but you don’t need to pay it back monthly like you do with a standard mortgage. Instead, the interest is added to the loan amount and the whole value is paid back when the house is sold, either when you pass away or decide to move elsewhere. If the interest builds up to be more than the value of the house, the borrower or the borrower’s estate will likely not need to pay back anything above the value of the property sold.
There are a couple of things to be aware of with lifetime mortgages:
They normally have a higher interest rate than an ordinary mortgage
There is no fixed term by which the loan should be repaid
Before taking out a lifetime mortgage, carefully consider whether it is a good option for you. A lifetime mortgage is ideal if you plan to live in the house for the rest of your life, but if there’s a chance you’ll need the equity for something else – for example, care as you get older or downsizing your home – then it might be best to consider other options for funding your retirement.
Bear in mind as well that if you are planning to leave your property to your children or family members, the interest built up on the lifetime mortgage over time may mean they do not receive anything.
You can choose to make payments towards your lifetime mortgage if you wish, lowering the amount of interest you’ll pay and leaving a greater amount of equity in the property. You can also choose an interest only lifetime mortgage which allows you to make monthly interest payments (and fix the interest rate) so the total cost is lower.
What about drawdown lifetime mortgages? These work slightly differently as they allow you to take money as and when you need it, rather than as a whole lump sum. Interest is only applied to the portion you withdraw. This means the interest you need to pay back will grow much more slowly, compared to taking out a large lump sum.
Home reversion schemes
You could sell part of your home – or all of it – to a home reversion provider as another way of funding your retirement. You’ll get a lump sum or regular payments in return, and you can continue living in the property for the rest of your life, so long as you look after it and pay the building insurance. You can also ringfence some of the equity – for example, to leave as an inheritance.
However, bear in mind that home reversion providers will often give you much less than you’d get if you sold your home on the open market, so if your goal is to make a profit then this probably isn’t the best option for you. It is, however, great for quickly accessing money without having to move home.
How do you choose the best option?
When choosing how to access the equity in your home, there are a few key things to remember:
Any sort of equity release is an income, so be aware of how each option will affect your taxation and eligibility to state benefits
Some forms of equity release will have arrangement fees, which could end up being around several thousand pounds. Be sure to take this into account when choosing, and remember to include any fees in your budget
If you change your mind the schemes can be complicated to get out of and doing so may incur additional charges – so make sure you’re certain before committing to anything, and always have a financial buffer just in case something unexpected happens and you need to get out of your contract
It’s best to consult a legal professional who specialises in equity to help you make the decision. Your solicitor will take into account your age, income, how much money you want to release and what your plans are for the future.
Consider what your plans are for your money, your home and your future in order to choose the right equity release product for you. You’ve saved and worked hard for your home – make sure it’s working hard for you.