Release Equity to Pay off Debt – 2022 Guide
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Is it possible to release equity to pay off debt? We’ve been asked this question a lot recently, so thought it best to provide a detailed guide on how to release equity to pay off debt.
Read on to uncover the finer details of equity release, before we get to the meat of the question.
What is equity release?
Equity release is an option for senior homeowners to access a lump sum of tax-free cash that they do not have to pay back until their home is sold, which usually only happens after death or if they move into long-term care.
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Who qualifies for equity release schemes?
Each individual equity release provider will have its own eligibility criteria that you must meet to apply for a plan. Some equity release schemes will require the homeowner to be at least 55 years old, while others may require the homeowner to be 65. In either case, it is the youngest homeowner (if jointly owned) that must suffice this age requirement.
The property you are releasing equity from must be your main residence in the UK, rather than a rental or holiday home. Additionally, there must be no existing mortgage on the property. Some providers will consider an application if your existing mortgage is very small and could be paid off with the equity release money.
How does equity release work?
Equity release works as a type of loan. The lender provides the homeowner(s) with a loan that is only repaid through the sale of their property, rather than through monthly payments as per most loans.
It may not feel like a loan because there are no recurring repayments, but formally it is a loan.
Home reversion scheme
A home reversion scheme is when an equity release provider offers you a loan for a percentage of your property.
You continue to live at the property rent-free and the loan doesn’t need to be paid back until the home is sold from your estate or sold to move into aged care. In this scheme, no interest is usually charged on the loan, but the offer made for some or all of your property is exceptionally low, typically less than half of its real value.
For example, you may be offered 20% of the home’s value for around 70% of the property.
Lifetime mortgages work in a different way to home reversion schemes and are more common in the UK. In the US and other places, they’re known as reverse mortgages.
A lifetime mortgage works with a lender agreeing to give you a loan for a percentage of your property. How much equity you can release will depend on the lender’s loan to value ratio and other factors. You continue to live in your home without paying any rent. There are no monthly payments to make as the loan is only repaid from the sale of the property, which only occurs after death or moving into long-term care.
The loan comes with a fixed interest rate that doesn’t have to be paid and rolls up, adding to the total debt. However, you can make interest payments to reduce the debt owed from your estate.
The benefits of equity release
There are a number of benefits of using a lifetime mortgage or home reversion plan. Here are the most significant:
- You can receive a lump-sum payment or a drawdown facility for a regular income.
- As these are a type of loan, none of the money is subject to income tax or Capital Gains Tax (CGT).
- You can continue living in your home without paying rent and cannot be evicted.
- The negative equity guarantee ensures that you’ll never owe more on a lifetime mortgage than the sale value of the property, which ensures your beneficiaries won’t have to cover any debts that exceed this amount.
- The money can be used for an array of purposes, including making retirement more comfortable
- In limited cases, equity release plans can mitigate inheritance tax payable on your estate.
What is the catch with equity release?
There is no catch with equity release as long as you use a company that is regulated by the Financial Conduct Authority and you fully understand how the plan works. By reading guides like this one, you’re already on track to fully understanding how equity release works, but you may also want to consider financial services and mortgage advice.
One common complaint about equity release is the value for money the homeowner receives, which could easily be considered a “catch”. With a home reversion plan, the amount you are offered is well below its real value, and with a lifetime mortgage, even a standard interest rate over a decade can more than double the total amount owed.
The good news is the negative equity guarantee, as mentioned earlier, prevents you from ever owing more than the value of the property and what it sells for, which therefore “ring fences” some inheritance for beneficiaries.
Can you lose your home with equity release?
One of the biggest concerns when considering an equity release plan is the possibility of losing your home. The worry is that after you agree to a lifetime mortgage or home reversion scheme, the lender will try to evict you from your home.
The good news is that you cannot lose your home after taking out an equity release plan. You can continue living in it as your main residence and do not have to pay rent. This is always the case when you use a legitimate equity release company that is authorised and regulated by the Financial Conduct Authority and the Equity Release Council.
If you want to make significant changes to the property – that could reduce its value – you may need to get permission from your equity release provider first.
Is equity release a bad idea?
Equity release can be a good and bad idea. To determine if it is a good idea for you, you’ll need to consider the specifics of the plans available against personal circumstances.
For example, someone without children may feel that equity release is a better idea for them compared to someone with children who they know are relying on an inheritance to make life more comfortable.
Having or not having children is by no means the only thing that decides if equity release is a good or bad idea. This is just one example.
Common reasons for releasing equity
As equity release is only possible for people over 55, and sometimes only for those over 65, this type of loan is mostly used to make retirement more comfortable. It may be used to pay for in-home care or help retirees see and do the things they always wanted to do but were unable to afford, such as going on worldwide trips or buying a sun-drenched holiday home.
Some people decide to release equity and gift some or all of the money to their family, which could help them buy their own family home, start businesses and more. For some people, gifting equity release could help reduce inheritance tax that would be owed by beneficiaries of a will, but this is a complex area and includes some risk.
Can you release equity to pay off debt?
You can release equity to pay off debt. If you have outstanding debts in later life, releasing equity and then using the money to pay off your creditors is possible.
Because equity release is a type of loan, then this would be considered debt consolidation, i.e. you are paying off multiple debts with a new debt. The big difference is that using equity an release plan to clear debts will not require any monthly repayments on the new debt, whereas using a debt consolidation loan requires immediate monthly repayments.
Can I borrow more on my mortgage to pay off debt?
It also might be possible for borrowers to borrow more on their mortgage to pay off debt. Although you secure a bigger mortgage against your home equity, this isn’t exactly the same as equity release. Monthly payments on the new mortgage will be due immediately after it is taken out.
It works by swapping your existing mortgage for a bigger one, and then using the extra borrowing to pay off debts. Thus, you have moved all your debt into one place. The new mortgage should have a lower interest rate compared to the cumulative interest being paid on the debts.
But you should also take note of additional fees, which could make this method of debt consolidation more expensive, such as early repayment fees on the original mortgage and the debts. Everything needs to be considered before making a move.
Is remortgaging to pay off debt a good idea?
It’s possible for many debtors to reduce the amount of interest they need to pay on their debts by remortgaging and consolidating those debts. They save money and no longer have to worry about juggling multiple monthly payments, which in itself reduces the chances of payment defaults and arrears.
It is worth it to remortgage to pay off debts if you can secure a lower interest rate and still save money after having to pay any additional fees, including but not limited to early repayment charges and closing costs.
It’s worthwhile doing research into the other methods of debt consolidation, as these could offer even better repayment terms.
Alternative ways to pay off debts
We have covered how you could release equity to pay off debt, and how you can borrow more on your mortgage to do the same. But are there any other ways to pay off your debt? Yes – and we’ll explain some of the most common here:
- Debt consolidation loans
Debt consolidation loans are a type of personal loan that must be used to pay off other debts. They may be unsecured or secured by one of the debtor’s assets – and they are sometimes still available to people with bad credit. They can be found at high-street banks, building societies and through online loan providers.
- Credit card balance transfer
A balance transfer credit card is a special type of credit card that allows the user to transfer credit card debts from elsewhere to the card. To do so you will have to pay a small fee, known as a balance transfer fee. The balance transfer card should have a lower interest rate than your other credit cards, and it is common for the card to have an introductory 0% interest rate. Overall, it is a way to consolidate credit card debts and save some money in the process.
- Debt solutions
A wide range of informal and formal debt solutions are available to debtors. For example, a Debt Relief Order could prevent creditors from asking for any monthly payments for a whole year, and if your finances have not improved by then, your debts are written off. There are different debt solutions based on your personal circumstances and the (amount of) debt you owe.
Seek debt advice first!
If you need personalised support and advice on how to get out of debt, we highly recommend speaking to one of the excellent debt charities operating throughout Scotland, England and Wales. Free financial advice is available from charities like Step Change or National Debtline, and all communications are 100% confidential.
Find out more about equity release
If you want to know more about equity release and paying off debts easily, MoneyNerd has plenty more free guides and articles. We specialise in helping people understand the different roads out of debt so you can make informed decisions and know your rights. Come back soon to read more of our content!