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 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 owe £50,000 to the mortgage lender, your equity in the property is £150,000.
Equity in a property will usually build as you pay off your mortgage, but it can also rise or fall depending on the property market. There is no guarantee that your property will increase in value. When someone owes more on a property than it is worth, this is known as negative equity.
How to use equity in your house
There are a number of ways you can access your home equity. The simplest is to sell your house. Many people use the equity from their current home to help buy their next one. Just remember that equity is the amount left after deducting anything you still owe on your mortgage.
This is what many homeowners do when they move. If you have paid off a large chunk of your mortgage, your equity can become a sizeable deposit for your next property. If you downsize to a smaller house, you may even be able to buy 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. If much of your wealth is tied up in your property, there are ways to access some of that money without moving out. This is known as equity release.
There are three main equity release options:
- 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 this reduces the amount of equity you have in your property by increasing what you owe, it may still be a useful way to raise money. The rates on a home equity loan are often lower than those for a personal loan.
Home equity loans are often suitable for people who have built up considerable equity in their home and want access to a larger sum of money, usually between £15,000 and £100,000. They are commonly used for home improvements and refurbishment, especially where the work may add value to the property.
You could also use a home equity loan to consolidate other debts and potentially access a better rate.
These loans work in a similar way to your main mortgage. They may be fixed for a certain period before reverting to a Standard Variable Rate (SVR), so it is worth shopping around when the fixed term ends.
Remember that if you cannot afford to repay the loan, your property may be at risk.
Lifetime mortgages
A lifetime mortgage can allow you to release money from your home to fund retirement without having to sell it. This can be appealing if you want to stay in your home rather than move to a smaller property.
Interest builds up on the loan, but you do not usually have to make monthly repayments as you would with a standard mortgage. Instead, the interest is added to the loan and the total amount is paid back when the house is eventually sold, usually after you pass away or move into long-term care or another property.
If the interest grows to more than the value of the house, the borrower or their estate will usually not have to repay more than the sale value of the property, depending on the terms of the product.
There are a couple of important things to be aware of with lifetime mortgages:
- They normally have a higher interest rate than a standard mortgage
- There is no fixed term by which the loan must be repaid
Before taking out a lifetime mortgage, think carefully about whether it is the right option for you. It may suit someone who plans to stay in the property for the rest of their life. But if there is a chance you may need the equity later for care costs, downsizing, or another purpose, it is worth considering other options.
It is also important to think about inheritance. The interest that builds up over time may significantly reduce the value of the estate you leave behind, and in some cases there may be little or nothing left from the property for your family.
You may be able to make voluntary payments towards a lifetime mortgage if you wish, which can reduce the interest that builds up and leave more equity in the property. Some products are interest-only lifetime mortgages, which let you pay the monthly interest so the total cost is lower.
Drawdown lifetime mortgages work slightly differently. Rather than taking a full lump sum at once, you withdraw money as and when you need it. Interest is only charged on the amount you have actually taken, which can help the balance grow more slowly.
Home reversion schemes
A home reversion scheme allows you to sell part or all of your home to a provider in exchange for a lump sum or regular payments. You can continue living in the property for the rest of your life, provided you meet the terms, such as maintaining the home and keeping up building insurance.
Some schemes also allow you to ringfence part of the property’s value so that a portion can still be left as an inheritance.
However, home reversion providers will often pay much less than the full market value of the share you sell. So while this can be a quick way to access money without moving, it may not be the best option if maximising value is your main priority.
How do you choose the best option?
When deciding how to access the equity in your home, there are a few important things to bear in mind:
- Any form of equity release could affect your tax position and your eligibility for means-tested state benefits
- Some options come with arrangement fees, which may run into several thousand pounds, so make sure you factor these into your budget
- These schemes can be difficult or expensive to get out of, so only commit when you are confident it is the right choice for your circumstances
It is usually best to speak to a legal or financial professional who specialises in equity release before making a decision. A solicitor or adviser can help you consider your age, income, the amount you want to release, and your future plans.
Think carefully about your plans for your money, your home, and your future before choosing an equity release product. You have worked hard for your home, so it is worth making sure it supports your long-term goals.