What is home equity?
Home equity refers to the outright value of a property you own. It can be calculated by working out the current market value of the property and then subtracting any debt secured against the property. For most people, this will just be their outstanding mortgage balance.
For example, if you own a house currently worth £160,000 and have a £120,000 outstanding mortgage, you have 25% home equity which is equivalent to a value of £40,000.
What can impact my level of equity?
The two things that can affect how much home equity you have are:
- The current market value of the property
- The amount of debt secured against the property
Most homeowners’ property equity increases through gradual increases in property value and by paying off more of their mortgage over time.
How can you use home equity?
Your home equity is an asset and it can be used to help you borrow money from banks and online lenders. You might be able to borrow more using a home equity loan compared to using some other borrowing methods.
What does releasing equity mean?
Releasing equity is the term used when you borrow money by securing the loan with your home equity.
Numerous types of secured loans can be used to borrow against your home equity, including the aptly named home equity loan.
What is a home equity loan?
A home equity loan is a type of secured loan from a lender where your home is used as collateral within the credit agreement.
By listing your asset as security in the home equity loan agreement, you can usually receive more favourable borrowing terms, such as increased borrowing or a lower interest rate due to less lender risk.
However, by borrowing against your home equity, you are putting your home at risk. If you fail to repay the loan as agreed, the lender can force the sale of your home to recover the money owed.
How does a home equity loan work?
A home equity loan provides the homeowner with a lump sum loan which is charged with interest.
The loan is deposited into the homeowner’s bank account to be used as they wish. The money is then repaid (with interest) through a monthly payment for a fixed duration until all of the loan and interest have been paid.
Some home equity loans are for less significant amounts and are usually repaid quickly. These are sometimes known as short-term home equity loans. Other home equity loans can be significant and take many years to repay.
How much can you borrow on a home equity loan?
You can usually borrow more money with a home equity loan than with unsecured loans. As you’re borrowing against your home equity, the amount of equity you have in your property will influence your borrowing power.
Most lenders will want to ensure you keep at least 20% equity in your home at all times, so you won’t be able to release all of your available equity. This is to ensure you aren’t at risk of negative home equity.
For example, someone with a £100,000 property and a £50,000 mortgage will have 50% home equity equal to £50,000. The lender will typically want the homeowner to keep 20% equity in their home, which equals £20,000 in this example. Therefore, they might be able to take out a home equity loan worth up to £30,000 – subject to checks and lender home equity loan criteria.
If you’re struggling to understand how much you could borrow using a home equity loan, it’s worthwhile consulting some home equity loan calculators. But be aware, home equity loan calculators aren’t always accurate and the information provided may not reflect the terms of the loan you’re offered.
Home equity loans for all purposes
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What is negative equity?
Negative equity is when you owe more on debts secured by a property than the current market value of the property.
This sort of situation usually materialises when the property value declines and/or when the homeowner misses repayments on their mortgage or other debts secured against their property.
If you have other questions relating to home equity loans like this one, keep reading further below.
What is the interest rate of a home equity loan?
Home equity loan interest rates are usually set at a fixed rate, meaning the interest rate you pay will stay the same throughout the repayment period.
Home equity loan fixed rates are subject to change. On average, these rates range from as low as 3% to 8%.
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Are home equity loan rates higher than mortgage rates?
The lowest home equity loan rates are comparable to interest rates applied to residential mortgages.
However, mortgage rates can sometimes be a little lower. This is because a mortgage is the first lien of credit secured against the property, also known as the senior lien of credit. Any additional borrowing secured by the property is known as the second lien or junior lien of credit.
This is significant because the first lien of credit has first access to any money raised from the property sale proceeds should the property need to be forcibly sold to repay debts.
If a homeowner is forced to sell their home and has negative equity, it could be that the mortgage lender takes most of the sale proceeds, leaving the home equity loan lender with not enough money to collect and clear its own debt with the homeowner.
So the home equity loan provider is taking somewhat of a greater risk and may charge a slightly higher interest rate. This is also why you cannot borrow against all of your home equity, which increases the danger of negative equity.
Best uses for a home equity loan
A home equity loan can be used for different purposes at the homeowner’s discretion. The most popular uses are:
- Home improvements
- Private medical bills
- Education costs
- Making a big-ticket purchase, such as buying a new car or going on a once-in-a-lifetime holiday
Making home improvements with a home equity loan can be especially beneficial because the improvements are likely to increase the value of the property and therefore increase your home equity.
Pros and cons of home equity loans
We have already discussed the pros and cons of equity loans in detail here at MoneyNerd. But here is a recap of the most references advantages and drawbacks of using a home equity loan:
The pros
- You’re able to borrow larger amounts than a personal loan or credit card. While most personal loans from a bank or online lender will let you borrow up to a maximum of £25,000, a home equity loan could let you borrow over £200,000 in some instances.
- Home equity loan interest rates are highly competitive and usually better than what is achievable with other credit options – unless you have an excellent credit rating.
- A fixed interest rate helps you budget for repayments easily.
- These loans are widely available in the UK with many lenders to choose between
The cons
- Your home can be repossessed if you fail to keep up with home equity loan repayments
- Some home equity loans have expensive setup and arrangement costs
- Some home equity loans have expensive early repayment charges and closing costs
- There may be a minimum loan requirement, sometimes around £10,000
If you’re worried about these drawbacks and fear this may leave you in lots of debt, or even bankrupt, you may want to read our guide on How to Avoid Home Equity Loan Pitfalls first.
Where can I get a home equity loan?
Home equity loans are usually offered by high-street banks and online lenders, some of which are special home equity loan companies.
It’s essential that you research the market before applying for a home equity loan. You may even want to use brokerage services to help you compare home equity loans.
How much does a home equity loan cost?
A home equity loan may cost a relatively small administration fee and then the interest you pay on your loan, which depends on the lender and your loan amount. If you take out a home equity loan with bad credit, you might have to pay a slightly higher interest rate.
At the end of the home equity loan repayment period, you may have to pay another fee called a closing cost. This is to discharge you from the loan and the work involved. Moreover, if you pay the loan off early, you may also need to pay an early repayment charge.
Thus, the total cost of home equity loans can differ significantly based on individual circumstances and the lender used.
How to apply for a home equity loan
You can apply for a home equity loan in a bank’s branch and you can even make applications online or through a broker.
You should be aware that no home equity loan application is ever guaranteed. We’ve discussed this further and how to improve your chances of approval in our Guaranteed Home Equity Loans post.
Is a home equity loan the same as a home equity line of credit?
A home equity line of credit (HELOC) is a variation of a home equity loan. The HELOC allows the homeowner to borrow against their home equity but there are some key differences.
Instead of receiving the loan as a lump sum, the HELOC provides the homeowner with a drawdown facility for a set period. During the drawdown period, the homeowner can take parts of their approved loan as they wish.
During this time, the homeowner only has to make interest repayments on the loan, which is why HELOCs sometimes get called interest-only home equity loans. Once the drawdown period ends, the homeowner starts to make capital and interest repayment until the loan has been fully repaid.
Another difference is that home equity loans usually have fixed interest rates, whereas HELOCs are typically offered with a variable interest rate.
A HELOC can save interest as interest is only subject to the amount of money drawn, and it can help with budgeting for larger (home renovation) projects.
Can I remortgage to release equity?
Yes, it’s sometimes possible to remortgage and release equity by increasing the size of your new mortgage loan.
What’s the difference between a home equity loan and a remortgage?
There are other ways of borrowing against your home equity other than a home equity loan or HELOC. You could ask for a further advance on your current mortgage (cash out refinance), or you could remortgage to borrow more.
Remortgaging to release equity is when you swap your current mortgage loan for another one, only the new mortgage is larger.
Whereas a home equity loan will create a separate debt against the property with separate fixed monthly payments, remortgaging will allow you to release equity without creating another debt. The additional borrowing will be tied into your new monthly mortgage payment.
There can be times when a remortgage is more beneficial than a home equity loan, which is discussed further in our Mortgage vs Home Equity Loan post.
Can I combine my mortgage and home equity loan?
If you have an outstanding mortgage and a home equity loan, there are times when it’s possible to combine the two debts. This would work by extending your mortgage (or remortgaging) and using some of the cash to pay off your home equity loan in full.
This might be beneficial if your mortgage will have lower interest than what is currently being charged on the home equity loan. But be aware that repaying the home equity loan early could trigger early repayment charges.
Is a reverse mortgage the same as a home equity loan?
No, a reverse mortgage isn’t the same as a home equity loan. Although a reverse mortgage is an option for seniors, it’s still possible to get approved for a home equity loan as a senior. Although it will be more difficult.
Is it smart to use a home equity loan?
A home equity loan can be a low-cost method of secured borrowing and allow homeowners to access more credit than is possible with other types of loans. If you need a loan, this option could be ideal for you. But you should also know the risks of using a home equity loan.
Speak to a debt charity if you want clarification or help to understand what’s best for you.
Should I release equity or get a personal loan?
A home equity loan will usually provide you with a better interest rate than an unsecured personal loan, but it does require you to list the property as security in the loan agreement.
You need to weigh up the risks between personal loans and home equity loans to make an individual decision.
Can you get a home equity loan with no mortgage?
Yes, it’s possible to get a home equity loan with no mortgage if you’re a homeowner. if you’ve paid off your mortgage in full then you will likely have 100% home equity. You can borrow against some of this home equity through a home equity loan.
Can I sell my house with a home equity loan?
Yes, but when you sell your home with a home equity loan outstanding, some of the sale proceeds will need to be used to pay off the home equity loan and any early repayment costs.
Can I use a home equity loan to buy another house?
You could use some of the money from a home equity loan to help you purchase another property. Using home equity loans to buy property can be complicated because the new mortgage lender will have to consider this debt when considering your new debt-to-income ratio within the mortgage application.
Can I use a home equity loan to pay off a mortgage?
You could use a home equity loan to pay off a mortgage, and there are times when this could save you money. Learn more about this possibility in this dedicated post.
Can I use the loan to consolidate debts?
Home equity loans can be used to pay off other existing debts, so you’re consolidating those debts within the home equity loan. This is beneficial if the home equity loan has lower interest than those debts, and thus potentially saving you money.
Can you have two home equity loans?
It’s possible to get approved for two home equity loans on the same or different properties, but getting approval for the second loan may be more difficult depending on how much home equity you have.
Can I get a home equity loan on a mobile home?
The majority of lenders won’t approve a home equity loan against a mobile home. This is because the homeowner doesn’t own the land these properties are built on and are subject to depreciation which could result in negative equity.
What is a family home equity loan?
A family home equity loan is a way of helping family members get on the property ladder.
What is a government home equity loan?
A government home equity loan is part of the Help to Buy Scheme, which is an initiative to help people buy their first home with a lesser deposit.
