Mortgage Equity Withdrawal involves homeowners taking out a bigger mortgage loan to be able to take out cash from the value of their house.
Mortgage Equity withdrawal is a way of converting wealth into disposable income. An increase in house prices on its own doesn’t increase consumer spending. However if people can remortgage then they can spend some of their increase in wealth.
For example if you bought a house for £100,000 with a £100,000 value mortgage and then the value of the house increased to £150,000 in theory you could take out a bigger mortgage of £150,000 against the new value of your house. This means that you will have £50,000 cash to spend. However it is worth noting that if you do who re-mortgage your house will end up paying more interest repayments over the course of the mortgage term.
Mortgage equity withdrawal is calculated by the Bank of England through the following formula:
- (Increase in house finance = Mortgage lending + Capital grants) – (households investment in housing = purchase of new housing +renovation of housing + costs of moving)
- Thus in times of falling house prices there can be negative equity withdrawal. At the moment in the UK equity withdrawal is approximately £11bn a year a significant contributor to UK’s growth
Economic Effects of Mortgage Equity Withdrawal
Mortgage equity withdrawal can play a significant role in financing consumer spending. In the UK it has often been associated with Consumer led booms e.g. in the late 1980s.
In the UK houses are by far the biggest form of wealth, therefore when house prices rises it has a significant impact on consumer confidence and consumer spending.
Deregulations to the UK mortgage industry in the 1980s made it easier for home owners to remortgage.
However excessive mortgage equity withdrawal is often a sign of an unbalanced economy. For example the rising spending which occurred in the 1980s proved to be unsustainable. It also contributed to rising inflation. The boom of the 1980s turned to bust in the early 1990s when interest rates were increased to combat the rising inflation.
However it is worth noting that a rise in mortgage equity withdrawal doesn’t always cause inflation. For example in the early 2000s mortgage equity withdrawal increased sharply because of rising house prices and low interest rates. However inflation in the UK has remained low. This is because other areas of the UK economy were weak. However although inflation is still low, some economists are still concerned that high levels of MEW are an indication of an unbalanced economy – illustrated by current account deficit.
Mortgage Equity Withdrawal and House prices
Mortgage equity withdrawal is very much dependent upon the housing market. When house prices are rising equity withdrawal will increase. But a fall in house prices can cause negative equity and a fall in consumer spending.