What is equity and how to use it for borrowing?

What is equity and how can you borrow against it?

Equity is the share you own of the value of your home. For example, if your home is worth £200,000 and your mortgage is £150,000, your equity is £50,000.

• How to access your equity– If you own any portion of your property you own equity, but how can you access it?
• Borrowing against equity – If you own equity you can access it through remortgaging
• Things to consider before remortgaging for cash– Before you remortgage you should consider the costs
• Alternative options– Remortgaging isn’t the only way to to access credit

There are two ways your equity can increase:

• Appreciation of the value of your home
• Your home value stays the same but you pay down your mortgage debt with a repayment mortgage (but not an interest-only mortgage)

It’s not uncommon for homeowners to borrow against their equity by remortgaging to get a cash lump sum, often to pay for home improvements that can add value.

With mortgage rates at all time lows remortgaging may seem like the cheapest way to borrow large sums of money, but borrowing more means paying more interest overall, so is it a better idea than a short-term loan?

How to access your equity

The most obvious way to access your equity is by selling your home. Typically, your equity is put towards a deposit to buy a new home.

If your equity has increased, you can use it as larger deposit and secure lower mortgage rates, or maybe even buy a home outright.

If you ‘downsize’ and move into a lower value home you will have freed up your equity into cash.

Borrowing against equity

If you don’t want to move home or downsize, you can remortgage to borrow against the value contained in your equity. This works by taking out a new mortgage that is larger than your existing mortgage.

For example, if the value of your home has increased from £150,000 to £200,000 since you took out your old mortgage, remortgaging enables you to cash-in on this increase in value without moving.

If you owed £100,000 to your existing mortgage lender, but you get a new mortgage of £120,000, you would be left with £20,000 extra, although there are various fees that will eat into that (the arrangement fee of the new mortgage for instance).

By remortgaging for a higher value you would have ‘sold’ £20,000 of your equity, as you would now only own £80,000 of the value £200,000 of your home, rather than £100,000.

Because of the increase in value of the home, your loan to value ratio has still dropped, but you are borrowing and paying interest on a higher amount.

Things to consider before remortgaging for cash

Before you consider getting a larger mortgage you need to weigh up the cost of remortgaging against the value of your equity.

Your equity – what to look at

• Work out the value of your home against how much of your mortgage you still owe. Your lender should do this for you, but will often charge fees, so it’s worth getting some estimates yourself before you commit.
• Look at how much your home has increased in value, and make a point of not increasing your loan-to-value ratio by borrowing proportionally with how much your property has increased in value. Fundamentally it is still about what you can afford to pay back.
• If you plan for your home to further increase in value to negate increasing the size of your mortgage, you are taking a risk. Just because property prices have gone up in the past, doesn’t mean they will continue to do so.

The cost – what to look at

• Look at the size of your current mortgage repayments and the size of your potential new repayments to see if you’re happy with larger monthly outgoings.
• Work out the total cost of the new bigger mortgage and see how much more interest you will pay over the lifetime of your debt.
• Take into account any exit fees from your current mortgage and arrangement fees for the new mortgage – if substantial they could eat into the equity you are releasing.
• The cost of currently available mortgage rates  – the price of mortgages goes up and down, getting a new mortgage rate at the right time, could mean your mortgage will cost you less. Conversely if rates go up your monthly payments could increase substantially.

Alternative options

If your personal circumstances, high exit/arrangement fees, or low equity growth mean remortgaging doesn’t seem like a sensible option to get a cash sum, there are a few other ways you can borrow.

Personal loan

A personal, or unsecured, loan will enable you to borrow amounts up to £35,000 over a time period between one and five years.

If you can afford to pay back the money within a year or two a personal loan could work out cheaper than borrowing money by remortgaging, but you may face some large monthly repayments.

Because a personal loan is unsecured lending offered against your credit score, you will need a good to excellent credit to borrow at headline rates.

Credit card

A credit card is a much more flexible way to borrow smaller sums up to about £5,000 – but credit limits vary with personal circumstances.

However, you cannot use most credit cards to borrow cash, only for credit. If you do use a credit card for cash you will pay extra fees and possibly a higher interest rate.

But unlike loans or mortgages you can adjust the size of your repayments each month, provided you meet the minimum repayments, which will be the larger of either £5 or a percentage of the amount owed (typically about 2%).

A low APR card, or 0% interest purchase card (provided you transfer the balance when the interest-free period expires), are typically the cheapest cards for borrowing.

Read more…

• Remortgaging guide – Our guide to remortgaging can help you decide if switching from your current mortgage deal is right for you
• Credit cards: the uSwitch guide – We explain everything you need to know about credit cards and how they can help you with your day-to-day finances.
• Loans explained: all you need to know – We have brought together all you could ever need to know about loans in this one-stop-shop guide.