What is a No-Equity Home Loan?

John Lister

A no-equity home loan is one in which the homeowner borrows an amount worth equal or more than the value of his home at the time the loan is taken out. This means that the borrower starts the loan period with no equity in his home. Such loans are sometimes referred to as a 100% mortgage or the equivalent figure. As such loans greatly increase the possibility of the lender failing to recoup the full loan amount if the house is repossessed, the loans generally carry a higher rate of interest.

People getting a no-equity loan.
People getting a no-equity loan.

The name no-equity home loan derives from the concept of equity. This is a figure that represents how much money a homeowner would have left if he sells the house at current market prices and repays the mortgage. In a loose sense, equity is the proportion of a home that somebody truly "owns" outright. In the event that house prices drop, it's possible that the homeowner may have more outstanding debt on the mortgage than the house would sell for. This is known as negative equity and can effectively mean the homeowner is "trapped" in his home by being unable to afford to move and pay off his mortgage.

A house bought with a no-equity home loan.
A house bought with a no-equity home loan.

In most cases, a mortgage lender will only lend a proportion of a home's purchase price to the buyer. This proportion is known as the loan-to-value ratio. The remaining money must be paid in cash by the buyer, an amount known as a deposit. For example, if a buyer bought a $200,000 United States Dollar (USD) property and was offered a mortgage with a 90% loan-to-value ratio, the bank would provide $180,000 and the remaining $20,000 would come from the buyer. In other words, the buyer would need to provide a 10% deposit. At the point of purchase, the buyer would have 10%, or $20,000, equity in the property.

A no-equity home loan is where the lender provides money making up 100% or more of the property purchase price. Such deals are normally aimed at people who cannot raise or have not raised enough cash for a deposit. In the event of a loan-to-value ratio of more than 100%, the buyer would have cash leftover after buying the house. This is often marketed as being a way to cover the costs of setting up a home, such as paying movers or buying furniture.

The big drawback is that the loan becomes far more susceptible to price movements. At any stage, there is a much greater chance of the market price having fallen below the amount the homeowner still owes on the mortgage. This becomes significant if the homeowner defaults and the lender needs to repossess the home and sell it to repay the mortgage. If this does not raise enough cash, the lender will need to pursue the borrower for the remainder, which is unlikely to be successful, given the homeowner will be in poor financial circumstances.

Because of this, a no-equity home loan will usually carry a higher interest rate. Ironically, this can increase the likelihood of the homeowner being unable to afford the repayments. Critics of such loans also argue that a potential buyer who is unable to save up for a deposit in the first place may be less likely to afford repayments on a mortgage.

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