Home equity
Home equity is the market value of a homeowner's unencumbered interest in their real property, that is, the difference between the home's fair market value and the outstanding balance of all liens on the property. The property's equity increases as the debtor makes payments against the mortgage balance, or as the property value appreciates. In economics, home equity is sometimes called real property value.[1]
Homeowners may leverage their home equity for various reasons, such as debt consolidation, home improvements, funding education, building an emergency fund, pursuing investment opportunities, planning for retirement, purchasing a new home, or paying off the mortgage early. Carefully weighing the potential benefits against risks like increased debt load, foreclosure risk, variable interest rates, and opportunity costs is crucial before tapping into home equity.
In the United Kingdom specifically, home equity represents a significant financial asset for homeowners that can be leveraged in various ways. As property values have risen over the years in many parts of the country, the equity held by UK homeowners has increased substantially.
One popular use of home equity in the UK is funding home improvements or renovations. According to Nationwide Building Society, around 27% of homeowners who took out a loan or mortgage for home improvements used their property's equity to finance the projects. Common renovations include kitchen and bathroom remodels, loft conversions, extensions, and energy-efficiency upgrades like new windows or insulation. These types of improvements can enhance the home's livability and may potentially increase the property's value.
For older UK homeowners aged 55 or over looking to access their home equity, equity release schemes have become an increasingly popular option. These allow homeowners to access some of the equity tied up in their property, either through a lifetime mortgage or a home reversion plan. Equity release can provide a lump sum or regular income stream. However, homeowners should understand the implications, which may include reducing the inheritance they can leave and potentially impacting their entitlement to means-tested benefits.
Home equity is not liquid. Home equity management refers to the process of using equity extraction via loans, at favorable, and often tax-favored, interest rates, to invest otherwise illiquid equity in a target that offers higher returns.
Homeowners acquire equity in their home from two sources. They purchase equity with their down payment and the principal portion of any payments they make against their mortgage. They also benefit from a gain in equity when the value of the property increases. Investors typically look to purchase properties that will grow in value, causing the equity in the property to increase, thus providing a return on their investment when the property is sold.[2]
Home equity may serve as collateral for a home equity loan or home equity line of credit. Many home equity plans set a fixed period during which the homeowner can borrow money, such as ten years. At the end of this “draw period,” the borrower may be allowed to renew the credit line. If the plan does not allow renewals, the borrower will not be able to borrow additional money once the period has ended. Some plans may call for payment in full of any outstanding balance at the end of the period. Others may allow repayment over a fixed period, for example, ten years.
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References[edit]
- ^ Mehmet Odekon (17 March 2015). Booms and Busts: An Encyclopedia of Economic History from the First Stock Market Crash of 1792 to the Current Global Economic Crisis: An Encyclopedia of Economic History from the First Stock Market Crash of 1792 to the Current Global Economic Crisis. Routledge. pp. 554–. ISBN 978-1-317-47576-7.
- ^ Martin, Allison. "Home Equity: What Is It And How Can You Use It?". Bankrate. Retrieved 2024-01-09.
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