Freeing up Equity in Your Home – Step-by-Step Guide
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“How do you get the equity out of your home?”
– Homeowners across the UK
This guide is all about equity release and the different methods you can use to release equity from a property. We’ll discuss some of the most used methods, why they are used and the potential pitfalls of releasing equity.
What is home equity?
Home equity is a term used to refer to the amount of value you own in your home outright, commonly expressed as a percentage.
To calculate your home equity, you must first work out the current value of your home. It’s crucial that you use today’s market value of your property rather than what you bought it for. Several factors may have changed its value since you purchased it.
Once you have the current value of your home, you then subtract any outstanding mortgage balance. You can then use the answer to this calculation and the value of your house to work out the percentage of the property you own outright, i.e. how much equity you have.
Home equity is best understood with an example:
What your home is worth today = £200,000
Remaining mortgage balance – £110,000
£200,000 – £110,000 = £90,000
You have £90,000 of home equity, which is 45%.
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What is equity release?
Equity release is the process of using an asset to release a lump sum based on how much equity you have, while retaining full ownership and use of the asset.
The most common asset used within equity release is a property. You can release equity from your home as a lump sum payment and keep living in the property as normal – and continue to make monthly payments on your mortgage (or new mortgage).
Sometimes you may be able to release equity and not need to make repayments. We discuss this possibility later in this guide.
Why do homeowners release equity?
Homeowners choose to use equity release methods for an array of reasons. Some of the most common are:
- Home improvements – completing home improvements can increase the property value and your home equity.
- Debt consolidation – debt consolidation is a process of merging your debts together under a lower interest rate. Accessing equity will enable you to do this.
- Buy another home – the equity can be used to help you put down a deposit for a second home or even help you move home when downsizing.
- Help family – releasing equity is common among older people who want to financially help out younger family members, especially those trying to buy their first property.
How do I release the equity in my home?
Some of the most common methods of property equity release are home equity loans, HELOCs, remortgaging or using a lifetime mortgage.
We have discussed these options below. If you decide to use one of these methods to release any amount of equity, you should only use a lender that is authorised and regulated by the Financial Conduct Authority. You should also consider the risks and seek professional advice first.
#1: What are home equity loans and HELOCs?
A home equity loan or home equity line of credit (HELOC) are types of loans that allow you to access credit based on the amount of home equity you have built up. Lenders will allow you to borrow up to a maximum of 80-85% of your accumulated home equity to create a responsible lending loan to value ratio (LTV). For example, with £100,000 equity you could borrow up to £85,000 maximum.
Home equity loans and HELOCs do not work the same way. A home equity loan gives the homeowner a lump sum with a fixed interest rate and monthly repayments begin straight away. Whereas a HELOC gives the homeowner a line of credit that is accessed like a credit card over a draw period. It’s usually after the draw period that monthly repayments begin with a variable interest rate.
How do you qualify for a home equity loan?
To qualify for a home equity loan or HELOC you must meet the lender’s initial criteria, which usually means being older than 18 with a certain level of income and a UK property that you plan to live in for at least six months of every tax year. Of course, you’ll also need to have built up enough home equity to be released. There may be a minimum amount you need to release, such as £10,000.
Upon application, the lender will assess your personal finances and income to ensure you can repay the debt in full. They’ll also complete a close search of your credit score and you may be rejected if you have unpaid debts and defaults.
You can release equity from your home by remortgaging. Understanding how to remortgage to release equity is fairly simple. When you apply for a new mortgage, you will apply for the same amount of money needed to repay your existing mortgage (consider early repayment fees too!) and then ask for an additional amount based on how much equity you wish to release.
For example, if you have a £100,000 existing mortgage and £100,000 in home equity, you could look for a new mortgage asking to borrow £130,000. This money will be used to pay £100,000 to your existing mortgage provider and you’ll have also released £30,000 equity.
How easy is it to remortgage to release equity?
The process of remortgaging to release equity is fairly simple. There are scores of lenders around that are willing to provide a new mortgage and simultaneously assist you in unlocking equity, but your applications will be subject to personal finances and your credit score. Lenders will need to know about all aspects of your finances to make a decision.
Remortgaging to release equity is more about getting it right and utilising a deal that doesn’t drastically increase your loan to value ratio and the interest payable. You’ll also need to factor in early repayment fees on your current mortgage.
Should I remortgage to pay off debts?
Some people choose to remortgage to pay off debts. In other words, they consolidate existing debts into their new mortgage. This can be beneficial if the new mortgage has a lower interest compared to the interest rates being paid on the debts, such as personal loans and credit cards.
However, this should be approached on a case-by-case basis considering other fees and charges. There may be more advantageous ways to consolidate debts, such as an unsecured debt consolidation loan or a balance transfer credit card.
#3: What is a lifetime mortgage?
A lifetime mortgage is a unique type of mortgage that allows you to access a significant amount of home equity and not have to make repayments in the immediate future. You’ll get access to the money tied up in your home and be able to use the money as you wish. The money will then be paid back to the lender from your estate when you die, which may include the sale of the property. You may have to pay back early if you sell the property and go to live at an aged care facility.
You should think carefully before using a lifetime mortgage, or the similar reverse mortgage, because it may prevent you from leaving your property to beneficiaries of your will. However, beneficiaries may be able to pay off the lender (including interest) and keep the home. It also involves fees to set up, which Money Helper estimates will cost up to £3,000.
If you do not plan to leave your property to family, this could be a beneficial way to access credit for your retirement or for other means.
What is the catch with equity release?
Equity release can sometimes sound like free money, especially if you are using a lifetime mortgage that you never have to pay back each month. But it is important to remember that the credit must be paid back from your estate and this is not free money. You’ll also need to pay interest on your borrowing.
You never know what life can throw you and your family’s way, and you could regret using a lifetime mortgage if your family’s circumstances change.
What are the pitfalls of equity release?
The biggest pitfall of releasing equity from an asset is releasing too much equity or more than what you need.
Keeping this credit unused in a modern low-rate savings account or spending it unnecessarily will only put you in a worse financial position. Even with a low-interest rate on a new mortgage, loan, HELOC or lifetime mortgage, you’re highly likely to be paying more than what you could save with the funds in the best UK savings account. Moreover, lenders will generally charge you higher interest if you start tapping into a lot of equity.
For these reasons and others, it is recommended that you only release equity that you genuinely need and nothing more. Of course, it can be difficult to accurately predict how much money you will need if you are completing large home renovations, but there is a solution for this.
A lifetime mortgage can be agreed with a reserve, which is an extra pot of money you can access from your equity if required – but not counted within the initial lifetime mortgage agreement.
What is negative equity?
Negative equity is when the value of your house decreases below the total value of your home equity and the remaining mortgage balance. For example, if you have £100,000 in home equity and £100,000 mortgage, but your house is now only worth £190,00 instead of its previous value of £200,000, you now have negative equity of £10,000.
This occurs due to a property decreasing in value for many reasons, some of which are outside the homeowner’s control. Lifetime mortgages and the other methods of releasing equity try to somewhat avoid this by only allowing you to release up to a maximum of 85%.
Is there a better alternative to equity release?
If equity release isn’t for you, you may want to consider alternative sources of credit, such as:
- A secured personal loan
- An unsecured personal loan
- Credit cards
And there are even more alternatives if you were trying to consolidate debts, such as a debt consolidation loan or a Debt Management Plan.
More info on accessing equity from your home
For further information on equity release and the ways of freeing up equity in your house, stick with MoneyNerd or come back soon to read other guides! We’ve got bags of information on equity release here.