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Home equity loans in the UK can help you more than just let you own your dream house.
People obtain mortgage loans so they can afford a house and finally have their dream home. Some people might not know though that you can use the property purchased with a mortgage loan as collateral to borrow a loan from financial institutions.
I’m sure by now you’re wondering how this is possible, using a house which you’re still paying off as collateral. Let me explain what I mean by that.
When you drop a down payment during the acquisition of a mortgage, the amount that you put down becomes your Equity (Home Equity).
This equity represents your stake in the house and it continues to increase as you make more payments. Your equity also changes as the market value of the purchased home fluctuates.
This leads us to what is known as a home equity loan, which is a loan that is secured using your home equity.
There are numerous financial institutions in the UK that offers Home Equity Loans but you need to understand how this loan works, so you don’t make the kind of mistake that can cost you a lot of money.
To properly educate yourself on the details surrounding Home Equity Loans In The UK, read and digest this article.
What is Home Equity?
Home equity is the amount that you have paid on your mortgage, whether it is partial or full. It is the totality of your down payment and the amount that you have since paid off. As the value of your home appreciates in the market and you continue to make payments, your home equity will continue to grow.
Also, when you make improvements to your home, it increases the value of the home, thereby increasing your home equity.
You can use your home equity to acquire home equity loans by putting the house down as collateral.
When trying to determine how much equity you have in your home, it is important that you use the present market value of your home and not the amount that you paid for it.
For example, if you purchased a £300,000 home that is still valued at that price, and you have an amount of £200,000 left to pay on your mortgage, this means that you have £100,000 home equity. It can also be expressed in percentage, which will make the percentage for this example 33%.
It probably goes without saying that if the market value of the house changes or you make improvements on the house, the figures will have to be adjusted.
Additionally, it is worth noting that one can only use 80 to 90% of your home’s value to borrow a home equity loan.
Upsides of Leveraging Your Home Equity
1. Since the type of loan acquired with home equity is a secured one (a loan borrowed using collateral), lenders consider it less risky, which in turn gets the borrower a favourable interest rate.
2. Using your home equity to acquire a home equity loan has tax benefits.
Downsides Of Leveraging Your Home Equity
- You might end up misusing the money gotten as a home equity loan, especially if you don’t spend it on expenses that will serve as investments.
- If the loan you borrowed has a variable interest rate instead of a fixed one, your payments might suddenly increase due to a rise in the interest rate.
- As practical as it is to use your equity to get a loan, the repayment period might be a tough one, since you will have to pay back two loans with two interests.
- You might have to pay additional fees, such as closing costs.
- If at the end of the day, you are unable to make payments, you might end up losing your home.
What is a Home Equity Loan?
Also known as a Home Equity Line Of Credit (HELOC), a Home equity loan is a type of secured loan where a borrower uses their home equity as collateral. They can use the equity that they have in their home to borrow a loan, and then repay the loan with interest within a period of time. The good thing about this loan is that you will get a good interest rate since you are using your home as collateral. On the other hand, you risk losing your home if you fail to keep up with your monthly payments.
This loan is also referred to as a second mortgage, as it is another home loan which you will have to pay back with interest.
Types of Home Equity Loans
There are two major types of home equity loans:
- Fixed-rate loans; and
- Home equity lines of credit (HELOCs).
Home Equity Loans In The UK: Fixed-Rate Loans
This type of home equity loan offers a single, lump sum of money to the borrower, which the borrower then repays with interest within a period of five to fifteen years. All through the loan term, both the monthly payments and the interest rate won’t change.
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Home Equity Lines of Credit (HELOCs)
This type of home equity loan applies an adjustable interest rate. It operates like a credit card and in some cases, a borrower is given a credit card to use for buying things on the line of credit.
How it works is that the lender sets a spending limit for the borrower and the borrower can use the credit card given to them to make withdrawals within a length of time (usually between five to ten years) known as the draw period. Once this period is over, the repayment period begins, which means it is time to start making your monthly payments. The interest rate here is variable.
Factors To Consider Before Taking A Home Equity Loan
1. Start by perusing your credit status.
2. Consider the amount of debt that you’re paying off at the moment.
3. Calculate your equity.
4. Ensure you’ve thought the whole thing true and have a clear understanding of what to do with the money.
Upsides of Home Equity Loans
1. It helps with debt-consolidation.
2. It gives a home owner an easily accessible source of finance.
3. Compared to other consumer loans, the interest rates on home equity loans are usually lower.
Downsides of Home Equity Loans
1. Due to the easily accessible nature of these loans, it might indulge borrowers who are in the habit of borrowing and borrowing, and this may push them deeper into debt.
2. If a homeowner uses this loan for the kind of home improvement that is valuable to him but not to the market, this will lead to a waste of money.
3. If you are already finding it very hard to pay off your current mortgage, it might not be wise to take on a second one.
Uses of Home Equity Loans
You can use your home equity to borrow home equity loans to take care of some other important expenses. Below are some of the ways you can leverage your home equity.
1. Pay for School Fees: Instead of borrowing student loans from the government or from a private lender, you could always use your equity to borrow a home equity loan to pay educational expenses. Since you’ll be putting down a collateral, the terms of the loan would be more friendly compared to getting an unsecured loan.
2. Fund home renovations: If you’re thinking of making improvements to your home, probably to increase your equity, you can take out a home equity loan and use the money to fund the project.
3. Unify high-interest debts: Another use of a home equity loan is to pay off other high-interest debts. The advantage of using a home equity loan to settle other loans is that mortgage debt is used to get a valuable asset. This means that although you would have incurred a debt, you would also have an asset that will continue to be of great value to you.
4. Remove your PMI: If at the time of acquiring a mortgage, you had to get private mortgage insurance (PMI) due to a low down payment, many lenders often accept the request to cancel your PMI if your equity stake gets to 20%.
5. Second mortgage: You can also use home equity loans to pay for a down payment on another property, and own a second mortgage.
How Do I Qualify For Great Home Equity Loan Rates?
Although each lender has their own borrowing standards and rates, below are the most common basic requirements:
1. A credit score of 620 and above.
2. A minimum of 20% equity in your home.
3. A debt-to-income (DTI) ratio of not more than 43%.
4. Proof that shows your ability to repay the loan.
What Is The Difference Between Home Equity Loans And Mortgage
Although home equity loans and mortgages have a lot in common, they also differ in some ways.
Basically, a mortgage is an amount of money that a borrower takes to purchase a home, while home equity loans are loans granted to homeowners who want to use their home as collateral to get money to take care of other expenses.
What is Negative Equity?
This is when the totality of your mortgage debt and any other loans that you might have used your home to secure, is higher compared to the value of the property. This can happen if you got some loans at a time when the value of your home was worth a lot but due to one reason or the other, the price came down. Now the amount of your debt is higher than what your property is worth.
What Is Equity Release?
This is when you release the equity that you have in your home by using your home as collateral for a loan. A loan is only paid back either after you die or after you decide to go into long-term care.
This means that you won’t have to worry about working to pay back the loan, instead, the sale of your home is used to repay the lender. This is why it is called a release.
Ensure to give it a lot of thought and be sure you’re ready to let go of your home, before deciding to release your equity.
Home Equity Loan Calculator UK
To find out the amount of equity that you have in your home, follow these simple steps:
- Know the value of your property.
- Do a sum of the total of how much is left on your mortgage and how much loan you have used the house to secure.
- Then deduct that total from the value of your property.
For example, If the value of your property is £300,000, your mortgage balance is £140,000, and you have an outstanding secured debt of £10,000, this means that your equity in the home is £150,000.
Home equity loans in the UK are easy to get and they can be used for a wide array of expenses. However, you have to be careful as to what you spend it on, so you don’t end up incurring more debt than you bargained for.