Ignorance about Homeowner Loans Hurting Equity

Michelle Tuvey Michelle Tuvey | Loan Underwriter

Do you have any homeowner loans you are paying on? If so, are they primary mortgages, second mortgages, or home equity loans? We ask after reading about a new report just released by L&C Mortgages suggesting far too many homeowners are wasting money by continuing with their current mortgage deals. Not only that but they are hurting their equity too.

The L&C Mortgages research shows that more than one million UK households are spending some £2.78 billion more than they should by sticking with their current standard variable rate mortgages, instead of switching to better deals. Even more alarming is data that shows approximately 3.4 million households do not even know what their current rate of interest is – or that they could potentially save thousands of pounds annually with a new deal.

Financial experts point out that such a lack of ignorance can create some significant problems if, and when, the Bank of England decides to raise the base rate. At whatever point the base rate goes up, so will the monthly mortgage payments of people still on standard variable rate deals. Some payments might even rise to the point of being unsustainable.

Monthly Payments and Equity

A significant disadvantage of standard variable rate products is the fact that they typically have higher interest rates attached to them. They may be attractive initially, due to lower monthly payments, but they are too volatile to hold on to for the long-term. This is why so many mortgage experts recommend sticking with a standard variable rate only for a limited time before switching to a fixed-rate product.

The equity question is also one not to be ignored. Equity immediately comes into play for standard variable rate homeowner loans when monthly payments rise or interest rates increase. Higher interest means less of the money being put toward payment is going to the principal amount borrowed. It also means that the total cost of borrowing increases commensurate with a higher interest rate. Both these conditions reduce equity.

Given that equity is the difference between what a home is worth and the owner’s outstanding mortgage balance, equity is built more quickly by reducing the amount owed on the mortgage. The combination of less money being put toward principal and spending more money on interest equates to paying off the loan more slowly and, subsequently, inhibiting equity growth.

Why This Is a Problem

To someone struggling to make monthly mortgage payments, the question of equity may be a non-issue. But it is still a problem that should not be ignored. To understand why it is important first to understand that equity is a financial asset. Equity increases a homeowner’s interest in his or her property while diminishing the bank's. It improves the owner's financial position by increasing the value of intangible property. And finally, equity makes it easier to borrow large sums of money if doing so ever becomes necessary.

Diminishing the growth of equity as a result of having an unattractive standard variable rate deal has just the opposite effect. The fact is, equity is a precious asset that needs to be guarded at all costs.

Ignorance of homeowner loans, interest rates, and the availability of better deals is hindering British homeowners from making the most of their properties. They are wasting money on interest payments that could be markedly lower, and they are harming their own equity position by doing so. If you have any outstanding homeowner loans, it would be a good idea to sit down and analyse just what you are paying. Then go and see if you can find some better deals.

Sources:

Property Wire – http://www.propertywire.com/news/uk/uk-home-owners-losing-millions-not-checking-mortgage-deal/

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