Property is expensive to buy. But there’s an upside to the cost of it all, and it’s called equity, one of the biggest advantages of home ownership. Do you know the details behind equity in a home? Whether you already own a place of your own or about to take the plunge, you’ll want to know the ins and outs of the potential equity of the house you’re in or buying. This article addresses a vital question: what is equity in a home. Read on to find out all about home equity and how to make the most of the opportunity. We’ll cover how to calculate how much you’ve earned, reveal what happens when equity takes a nosedive, and talk about what you can do with the money.
What Exactly is Home Equity?
First, let’s nail the definition. What is home equity? Your home’s equity is the value of your property minus the amount you owe on the mortgage.
What is good equity in a home? When it’s positive, home equity is a useful financial asset. You can’t access the cash straight away, it’s a longer term tactic to generate money. You buy a home which increases in value over time, ultimately worth more than you paid for it. Stay there long enough while house prices steadily rise, as they tend to most of the time, and the equity grows while your repayment mortgage debt reduces.
So what is equity in a house in real-life terms? Here are some simple examples. Say you bought a three bed terraced town house in Middlesbrough for £2,300 in 1970. Now it’d be worth anything from £125,000. If it was in London it would have cost more but by now it could be worth a million or more. You might have bought the same kind of house in Brighton for £53,500 in 1995, worth £150,000 by 2001. Or you might buy a home now for £250,000 and add a few thousand to the value in just a couple of years. Basically, the amount of equity you generate depends on the housing market, which in turn depends on the economy.
You don’t have to sell your home to benefit from the equity you’ve made. You can access equity in a home in various ways, and use it any way you like. If you’ve wondered why home equity is important, there are plenty of good reasons. It gives you a buffer against property value fluctuations. You can use the value tied up in your home to get loans, and plenty of other reasons. We’ll talk more about how to use your home equity later.
How to Build Home Equity
As you’ve seen, the equity of the house grows over time. So what about how to build equity in a home? Is there anything you can do to speed the process up, can you generate more equity and do it faster?
The price you pay in the first place matters, connected to the condition of the place you buy. The less you pay, the more the value can rise. You could buy a perfect house at the top-level price for the area, but there’s less potential for improvement than a place that needs some doing up, bought in the lower price bracket.
When you reduce your mortgage debt, property price rises have a more dramatic effect on your equity. The less you have to pay back, the more equity you build up. The same goes when you put down a large deposit, cutting down your repayments right from the start. If you come across any spare money, maybe a bonus, it makes sense to pay off a chunk of mortgage with it.
The better the property, the more it is worth. You could increase the value of your home by extending it, adding another bedroom in the roof or making the kitchen bigger. If the garden is big enough you could maybe build a garden office to add value. The simple act of making a home clean and fresh with new paintwork and carpets or flooring can make an instant difference to the value. Transforming the garden from rubble to a green oasis can make a great difference to the value of a home. Renovations are packed with potential, making a place a lot more desirable therefore more valuable.
The property market itself is a vital factor, but you don’t have any control over it. Like every kind of investment, home prices can fall as well as increase, leading to negative equity. We’ll cover that later in this guide.
How to Calculate Your Home Equity
How do you calculate home equity? Here’s an example.
- Current home value: £250,000
- Mortgage deposit: £10,000
- Outstanding mortgage: £232,500 after repaying £7,500 of the capital via your mortgage
- Your home equity is £250,000 minus £232,500 = £17,500
Remember interest-only mortgage repayments don’t affect the amount you’ve borrowed, which means the amount you have borrowed doesn’t go down over time. Your monthly payments will be lower but when the mortgage ends, you’ll repay the amount you originally borrowed.
What is good home equity? It’s called positive equity for a reason. Positive home equity is good, negative home equity isn’t so good – but it isn’t a disaster.
What is Negative Equity?
What is negative equity? You are in negative equity when you owe more on your mortgage than your home is worth. It doesn’t happen often, the trend is almost always upwards.
If you only put down a small deposit in a volatile market, where property prices ultimately drop, you might find you go into negative equity faster than you’d be if your deposit was bigger. It sounds terrible but unless you’re desperate to move house or keen to leverage any equity in it, it isn’t the end of the world. You can simply stay put until the value of your place recovers and you enter positive equity.
Here’s a simple example of negative equity.
- Buying price: £250,000.
- Mortgage deposit: £10,000
- Current home value: £230,000
- Outstanding mortgage: £232,500
- Your home equity is £230,000 minus £232,500, leaving you £2500 in negative equity
How to Use Home Equity
What is equity in a house for? What can you do with this windfall? You can use the equity in your home in all sorts of ways. The more deposit you can put down the better, so maybe think of it as the deposit fund for your next home. Lenders like good risks, and as someone with equity in your home you’re a great bet, in a position to secure loans. You might use the equity release to make retirement more fun. You might want to redecorate your home, extend it, fund a child’s first step on the property ladder or even buy another property to develop or let.
Now you know all about home equity and understand what is good equity in a home. If you’re a first time buyer it’s worth considering. Think things through bearing home equity in mind to make the best home buying decision.