Releasing equity for home improvements is a hot topic right now – and we’ve joined the debate. This guide will explain what releasing equity for home improvements is all about, the methods to achieve it and the potential risks.
If you have your eye on a new kitchen, extension, loft conversion or any other renovation idea, you should learn all about releasing equity for home renovations.
What is home equity and equity release?
Home equity is a term used to refer to the value of your home you own without any debt attached.
Most people buy a house using a mortgage, and until the mortgage is completely repaid they do not own the property outright. As monthly mortgage payments are made, the property is slowly becoming the buyer’s.
Home equity is a way of determining how much of your home’s value you own and/or a percentage of the property that you own without debt attached. You can calculate your own home equity by subtracting your mortgage balance away from how much your home is worth. For example, a home worth £220,000 with a remaining mortgage of £150,000 would equal £70,000 in home equity. Equity can also be increased by rising property prices in your area.
So, what does that make home equity release? Releasing equity from your home is when you borrow against your accumulated equity. For example, if you have £70,000 home equity you might take out a financial product – such as a loan – that allows you to borrow by using your home equity as collateral in the agreement. Thus, home equity can be used to secure credit and determine how much you can borrow at most – subject to credit checks and the lender’s loan to value ratio.
Can I release equity from my home for home improvements?
If you have home equity, you may be able to use it to access credit and fund home improvements. There are different ways and products used to do this, which are discussed shortly in this guide. In fact, home improvement projects are one of the most common reasons – if not the most common reason – for releasing equity. It can be a smart choice because doing so can increase the value of your house.
Other common reasons to release equity are to consolidate existing debts, buy another property in the UK or abroad, or to pay for expensive cars, private medical bills and holidays.
How do you release equity to renovate?
To release equity to renovate you must borrow against some of your available equity. This means taking out credit and securing the credit agreement with your equity. There are multiple credit options when borrowing against your home equity (see below).
Applications for products to release equity will depend on how much equity you have and your credit score. Just because you have home equity will not automatically guarantee you can access credit that is secured against it. Your personal circumstances and finances will be rigorously assessed.
By using home equity as collateral within the agreement the lender may be able to offer a lower interest rate. If you do not repay the credit as agreed then the lender can force you to sell your home to repay the debt, known as foreclosure.
Methods of releasing equity for home improvements
Here you can find six of the most common ways that homeowners choose to release equity for home improvements. If you need help working out which option is best for you, there are money advice groups and commercial services you could consider. It may be the case that no single option is more advantageous but what you choose will depend on what you are offered by different lenders.
- Remortgage for home improvements
It is possible to remortgage to release equity for home improvements.
Remortgaging is when you switch from your existing mortgage to another mortgage with more beneficial repayment terms, such as lower interest on monthly payments. The planned new mortgage is used to pay the amount you owe on the existing mortgage so you still only have one mortgage at one time. But because you are ending your first mortgage earlier than planned, you may be subject to early repayment charges.
When you remortgage for home improvements, instead of looking for a new mortgage that simply pays off your current mortgage, you look for a mortgage that does that and more. The new mortgage loan needs to be larger than the amount owed on your current mortgage, and this extra amount is secured by home equity.
For example, if your current mortgage has a £100,000 balance and you have £70,000 home equity, you might look to remortgage for £130,000 instead. The first £100,000 will be used to pay your existing mortgage and the other £30,000 will be paid to you as a lump sum loan secured through home equity.
- Second charge mortgage
A second charge mortgage is when you release equity by adding a second mortgage to the same property. It is an alternative option to remortgaging for home improvements and doesn’t mean you’ll need to pay early repayment charges because the first mortgage is not being paid back earlier than agreed. You simply take out a second mortgage on the same property secured by an amount for home equity and then make monthly repayments to both mortgage providers.
Although you avoid early repayment fees, you may be subject to other fees when taking out a second mortgage, including closing costs when this mortgage ends. Therefore, it isn’t a straightforward choice between second charge mortgages and remortgaging.
- Lifetime mortgage (Reverse mortgage)
A lifetime mortgage – sometimes referred to as a reverse mortgage – is another method of equity release for home improvements specifically for senior citizens who own their home outright already.
Lifetime mortgages work by providing up to 100% of the homeowner’s home equity as a lump sum payment. This means they can access hundreds of thousands of pounds in some cases. Unlike remortgaging and second mortgages, this payment is not paid back through regular repayments.
The total cost of the mortgage is repaid upon the death of the homeowner(s) through the sale of the property or through their estate. Or it will be repaid early if the property is sold for the homeowner to go into an aged care facility. The homeowner cannot be forced out of the home if they do not need to go into care.
This method can be used to fund a home improvement project, but it is also used to improve quality of life in retirement or for financial gifts to family members. Most people choose to discuss this option with family members who would be beneficiaries of the property to ask their opinion or keep them informed of their decision.
- Home equity loan
A home equity loan is a type of secured loan and similar to a second charge mortgage. Some experts even refer to home equity loans as second mortgages. These loans are secured with home equity but usually come with a fixed interest rate. T
The homeowner receives the loan as a single payment to be used as they wish, often for a home improvement project. The homeowner will pay back through monthly repayments for a fixed period until all of the loan and interest have been repaid. If they fail to repay the lender can initiate foreclosure, forcing you to sell the property to recover the loan debt.
- Home equity line of credit
A home equity line of credit (HELOC) is a variation of a home equity loan that also leverages home equity. It works in the same way with some big differences.
The money is not paid through one deposit but through multiple payments over a draw period. The homeowner draws money from the loan over time, which can be useful when trying to stick to a home renovation budget split into different stages.
During the draw period, only the interest is paid back. And after the draw period ends, the homeowner must start repaying the principal loan amount as well as interest for a fixed time frame until all the debt is repaid.
- Secured loan
Sometimes you can get a secured personal loan that uses home equity as collateral, such as a secured home improvement loan. When using home equity as security instead of a vehicle or other asset, these loans are almost identical if not the same as some home equity loans and second charge mortgages.
What are the pitfalls of equity release?
The pitfalls of equity release may differ somewhat based on the methods used to do so. For example, some of the potential risks of releasing equity with a remortgage may be slightly different from those using a HELOC or lifetime mortgage. However, there are some general risks when releasing equity. These are:
- Negative equity – if the property becomes less valuable over time, you could end up having to pay more back on attached debts than it is worth. This is known as negative equity and is a greater risk the greater the percentage of equity you release.
- Debts become unaffordable – by releasing equity you are increasing your debt to income ratio. If your income was to decrease then your payments could become unaffordable and you may be forced to sell the home to try and repay. Combined with negative equity this could be disastrous.
Is equity release a good idea?
Releasing equity for home improvements can be a good idea for some homeowners. By using the money to improve your property, you could simultaneously increase the property value and your home equity again. This is especially true if you create an extension, loft conversion or add a conservatory.
However, sometimes there are more advantageous methods of financing home improvements with reduced risk. Whether it is a good idea or not will come down to personal circumstances and affordability.
If you do decide to release equity for home improvements, it is best not to release more than you need. Doing so increases the chances of dreaded negative equity and will limit how long extra it will take to own your home outright.
Other ways to fund home improvements
Releasing equity can be a beneficial way of financing your home improvements, but it’s certainly not the only way. If you cannot release equity or simply prefer not to, here are some alternative options:
- Save – saving up will make paying for home improvements cheaper because you won’t be subject to creditor interest rates.
- Credit cards – credit cards can be used to pay for renovations and may come with an introductory 0% rate.
- Home improvement loans – these are either unsecured or secured loans that are specifically used for home improvement projects.
- Personal loan – a wide range of personal loans are available to people with good credit.
Only use lenders that are authorised and regulated by the Financial Conduct Authority (FCA). You can check their credentials on the Financial Services Register.
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