Equity is the difference between what you owe on your mortgage and what your home is currently worth
Mortgages are constructed by banks where they front load the interest payments, meaning that if you took out a mortgage for example of €300,000 at 3.5% over 30 years, it will take 11 years before more of your monthly repayment is going towards reducing the capital, than it is towards interest.
In this instance, payments of €177,804 were made but the amount owed has only reduced by €75,886. And if people take notice of their loan offer, particularly the information section, they’ll see all of this detailed in an amortization table.
And I would urge anyone to take a closer look, because some serious data is revealed in those pages, particularly that table. Don’t skip by it because it’s a page full of numbers, take a close look because it will show what % of your loan repayment is applied towards interest and capital repayments each year, and what balance will be outstanding on your mortgage at a particular period of time.
The reason why this is important, is because building in your home allows you to move in the future, if that’s an option you want to have. So, if your first property isn’t going to be your forever home, and you see yourself/yourselves in it for perhaps the next five or six years and then moving on, you need to be super aware of what the balance will be in the future.
And when it comes to the equity you have in your property, the only thing you can control is how much you owe. You have no control over what the value of your property will be. There are just too many factors outside of your control to predict with any degree of certainty, what your property will be valued at in the future.
So, control what you can control which is why taking notice of the balance owing each year is very important, and that applies whether you’re ever thinking of moving or not.
And the control mechanisms you can exert on the balance are as follows and are based on a mortgage of €300,000 over 30 years:
Getting the best interest rate possible
The difference of 1% on a loan amount of €300,000 would mean the balance on your mortgage in 10 years’ time would be €8,867 lower.
It’s not enough to just compare the monthly repayments of the various lenders you’re considering, you’ve also got to be cognisant of what any differential in rates will have on your future balance. It has, to be a factor and included in your decision-making process.
Paying an extra amount each month
Overpaying by €200 extra each month will mean the amount you owe will be €28,912 lower than had you just made the normal repayment.
And the key to getting the most out of this strategy is to start making those overpayments early in your mortgage. You know how much interest is being applied from the outset and if you delay making those overpayments, that’s interest you’ll never get back for those years you didn’t make extra payments on.
Choose a shorter term
If you chose a 20-year term instead of a 30 year one, the amount you’d owe in 10 years’, would be €55,754 lower.
All three strategies can build equity in your property faster and distancing the amount you owe from what the property is worth is important, of course it is. And obviously challenging yourself to a lower term has the biggest impact in building equity and building it fast, but all three protect you somewhat from the unknowns of what your property will be valued at in the future.
When we take out a mortgage, we tend to focus more on the monthly repayment than we do on the total interest we’ll end up paying back, and it’s natural to only focus on the monthly cost because that’s something you can immediately feel, given there’s an amount being deducted from your account each month.
Reducing interest payments is an unseen benefit, because there’s nothing being lodged into your account ever month. The benefit is more long term, and can be monetary and non-monetary at the same time i.e. it allows you to move to your forever home in the future, it allows you to earn and work less, or you can redirect what once were mortgage repayments to savings or pension funds when your mortgage is finished etc.
Without going on and on, it’s important to understand how much of your home you actually own. Yes, it’s yours but not entirely until its’ paid off in full. The value you personally own is the difference in what the property is worth and what you owe, and you want to know what this number is because it can influence interest rates, whether you can move property, how much interest you pay, or even borrowing against it to finance another property purchase.
So, lots of reasons why it’s important to take stock and why you should take your time analysing all pages contained in your loan offer. Don’t just skip by the pages that have lots of tables and numbers, they’re really important, and you need to take notice of them. They’re your insight into what the future might hold for you.
Liam Croke is MD of Harmonics Financial Ltd, based in Plassey. He can be contacted at firstname.lastname@example.org or www.harmonics.ie