The amount of equity homeowners hold in their property on average is falling, as property prices mean lower deposits are being put down. The latest statistics reflect larger trends within the property market, including the average age of first-time buyers rising. But what does lower levels of equity mean for homeowners?
In simple terms, equity in a property is the portion that you own. So, if you borrowed 90% of the property’s value through a mortgage, your equity is 10%. As you make monthly repayments, assuming you choose a capital repayment mortgage, the amount of equity you hold will gradually increase until the debt is paid off. The ratio of equity to how much you owe is known as the loan to value (LTV).
Whether you’re purchasing your first property or remortgaging, the amount you can put down as a deposit has an impact. However, the amount of equity homeowners hold has been falling. Research from Royal London found:
- In 2007, the majority of 31-25-year olds were able to find a 25% deposit. By 2013, most of this group are borrowing more than 75%, reflecting the rise in first-time buyer age, which is now 34.
- In the decade since the financial crisis, there has been an increase in the number of borrowers in all age brackets with relatively small deposits (5%-25%).
- The age at which homebuyers are borrowing less than 30% of the value of their property has also risen. In 2007, this was 51-55, it’s now 56-60.
Why are average equity levels falling?
There are two key reasons why the amount of equity the average homeowner has is falling:
- House price growth: When house prices rise fast, borrowers are able to increase equity at a quicker pace. Following decades of fast-rising property prices, the pace has recently slowed down and even stagnated in some places of the country.
- Mortgage terms: House prices rising faster than wages in the past means it’s now more common for homeowners to take out a mortgage that lasts longer. As a result, it’s longer to reach lower LTV brackets.
Becky O’Connor, Personal Finance Specialist at Royal London, said: “For those who already own their home, house price inflation is a windfall, giving them a bigger deposit when they remortgage and enabling them to access lower mortgage rates.
“But those still waiting to buy a home when house prices rise must stretch to a higher loan-to-value (LTV) initially and then face the likelihood of being stuck paying higher rates on the higher LTV for longer if house price growth remains relatively flat. Now that house price growth looks to be levelling out, it could potentially take these younger, more stretched borrowers longer to get their LTV level down than was the case for homeowners who got on the ladder some years ago and benefitted from big house price gains.”
If you have low equity in your home, there are two key ways it may be affecting you: the level of interest you’re paying and the risk of negative equity.
Interest rates
As you move up through the LTV brackets, the level of interest you pay on mortgage repayments will change too. Typically, the more equity you hold, the lower the rate as you pose less of a risk to lenders. A deposit of 25% is often considered the ‘tipping point’ for accessing the most competitive rates.
When comparing interest rates, it can seem like there’s little impact. But when you take a look at how it affects monthly repayments and the overall amount of interest paid, it should encourage you to keep an eye out for the best deals. Take a mortgage of £250,000 over a 30-year period, for example:
- An interest rate of 3% covering the entire mortgage period would mean monthly outgoings of £1,054. Over the three-decade period, you’d pay a total of £379,444; interest totalling £129,444.
- However, if the interest were 5%, monthly payments would rise to £1,342. And this has a significant impact on the overall amount of interest you’d pay, taking it to £233,139.
Negative equity risk
The lower the equity you hold in a property, the greater the risk of falling into negative equity. This is where you owe more to your lender than the house is worth. If house prices start to fall and you only own 5% of a house, you could find yourself in this position. This can be a worry, particularly if you plan to move relatively soon. Negative equity can make it impossible to sell, as you’ll have to make up the shortfall, and to get a competitive interest rate.
Whilst homeowners with higher levels of equity will be disappointed should the value of their property fall, they have a larger cushion of protection should it happen.
If you have questions about equity in your home or how to secure a lower interest rate on your mortgage, please get in touch.