The term ‘home equity’ has become a bit of a buzz phrase. Property values have increased around the country, and many New Zealand homeowners will be wondering what this all means for them.
Let’s break it down simply.
What is home equity?
Home equity is essentially the total value of your home, minus what is owed to a lender. Most people purchase property by saving up a deposit (a share of the total cost of the property) and borrowing money (a home loan) from a bank or other lender to cover the rest, which is then paid off over an agreed period of time. Equity is what you’d walk away with if you sold up and paid off the lender. The equity you have in your property could increase over time as you pay back what you’ve borrowed, or as the value of your property increases. Equity is an asset – think of it as the share of your property that you truly own. It’s worth noting that the council capital value and the market value of a property are often different – the council valuation will remain the same for the duration of the three-yearly revaluation cycle, but the property market fluctuates regularly, and ultimately it’s the market that determines the true value of your home.
What is a CV and how does it affect my mortgage?
Capital value (CV) is the value assigned to a property by the council to calculate what share of the region’s rates the property owner must pay. CVs are based on the value of the land the property sits on, plus any ‘improvements’ made to that land – for example, a house. Usually, the higher the CV, the higher the rates. CVs are typically ‘desktop reviews’ (not involving a valuer actually visiting your property), and look at surrounding properties and recent sales data to inform a change in value.
The council valuation of your home is important because it’s one of the factors a lender could take into account when determining the value they will lend against and ultimately how much you can borrow.
Why does equity matter?
In a nutshell, the more equity you hold, the better your position when it comes to negotiating with lenders, at the time of new borrowing. In October 2013, the Reserve Bank of New Zealand (RBNZ) put restrictions (Loan to Value restrictions) on lending to potential homeowners who have a deposit of less than 20% of the value of the home they wanted to buy. For banks, these restrictions mean that only 15% of the bank’s lending for new home loans can be given to customers with a 20% deposit or less.
It’s a measure designed to support the stability of the financial system, but it can make it more difficult for borrowers to get a loan.
Could you get a better deal?
This is where it gets interesting. If the recent revaluations suggest you have a stronger equity position, you could renegotiate with your lender for a better rate at the time you apply for new or additional home lending. The main thing to keep in mind is that banks are required to record the value of the property at the time the loan was originally taken out, to work out how much capital they need to hold for the loan.
Capital is money banks (and other businesses) set aside to ensure they can continue to function – in this case, it’s money that’s set aside in case a borrower cannot repay a loan. For every dollar the bank lends out, a certain amount of money needs to be set aside because there is a risk that the loan may not be repaid. The higher the risk, the more capital has to be set aside. This affects the cost of lending (how much resource needs to go in to a loan) for banks and so they may be reluctant to alter the interest rate unless there has been some new lending or refinancing that allows them to use the “new” valuation.
If you’re thinking about taking advantage of your increased equity, it’s important to make sure that you have the ability to service (pay back) any extended or new lending you agree to. In this same vein, using your equity to reinvest in your asset (e.g. improving the value of your property via renovations) may be better than using It to making discretionary purchases like that flashy new car or boat that you’ve always wanted.
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