There are many different ways of extracting equity from your property with different options more appropriate for different scenarios.
What Is an Equity Mortgage?
An equity mortgage is sometimes referred to as a second mortgage and is a means of extracting equity from your property. If there is an existing mortgage, then there may need to be a second charge applied to the property, but this is a lot more straightforward than it sounds.
There is a subtle difference between a mortgage and an equity mortgage. The traditional mortgage is used to acquire a property which is then used as collateral to secure the loan (first charge).
With an equity mortgage, you are simply extracting capital from your property using your equity content as collateral. In effect, an equity mortgage is very similar to a loan secured against assets you already own.
How Much Can I Borrow on an Equity Mortgage?
If for example, you have a property worth £250,000 with an outstanding mortgage of £100,000 then, in theory, you have equity of £150,000. If we take an LTV ratio of 80%, an equity mortgage company will work out the maximum borrowings, including the outstanding initial mortgage in their calculations. So 80% of the £250,000 value is £200,000.
We then subtract the existing mortgage of £100,000 which leaves the potential to raise an additional £100,000 via an equity mortgage. This would still leave £50,000 of equity in the property, which would be the buffer between the combined debts on the property and its value.
So you would have a property worth £250,000, the combined mortgage debt of £200,000 leaving £50,000 in equity.
What Is a First Charge and Second Charge?
When you take out a traditional mortgage to acquire a property, a first charge will be given to the lender so that in the event of default they could sell the property and pay off the outstanding mortgage.
A second charge is, as the name suggests, second in line to the initial charge but is still a charge against the property. There is a general misconception that the holder of a second charge has no right to repossession unless the first charge has been enacted.
What Value Are Second Charges?
In the event that a borrower was to default on their equity mortgage, the lender could use their second charge to repossess and sell the property. The main issue here is that any proceeds raised will be offered to the first charge holder to repay the borrower’s mortgage debt with any surplus used to repay the secondary, equity mortgage debt.
In reality, a lender would only authorise an equity mortgage if there was a significant level of equity in the property, above and beyond any outstanding mortgage debts.
Why Take Out a Second Mortgage?
For many people, the automatic response when looking to release equity from their home would be to remortgage, pay off the existing mortgage and withdraw surplus funds.
The problem is that some mortgages may incur significant setup fees or there may be penalties for early repayment. Therefore, if we assume that you are looking to raise an additional £40,000, but the early repayment fees on an existing £50,000 mortgage were £10,000, this might make you think again.
You may find that the setup fee for a secondary mortgage, i.e. an equity mortgage, maybe £5000, which is a saving of £5000.
There are other reasons why you may look towards an equity mortgage if, for example, the initial mortgage was on an attractive interest rate.
If this could not be replicated by remortgaging, then you would benefit from the low-interest rate on the initial mortgage even though the interest rate on the equity mortgage would be higher.
Just because you have equity in your home does not automatically mean that you will be eligible for an equity mortgage. You will still need to take an affordability test which will take into account repayments on your equity mortgage as well as your outstanding traditional mortgage.
If you failed the stress test, which takes into account different interest rates, then your application will be rejected.
It is therefore advisable to do some prep work on your finances if you believe you may be struggling with the combined affordability test. Create a workable and realistic budget, detail existing income and work out funds available to cover both the first mortgage and the second mortgage.
If you can present a plan of attack to an equity mortgage lender which is reasonable, accurate and something you can abide by in the longer term, there is no reason why you shouldn’t be able to secure equity mortgage finance.
Are There Any Alternatives to an Equity Mortgage?
There are a number of alternatives, many of which are dependent upon the age of the borrower and the level of equity in their property.
As we touched on above, there may be issues with early repayment penalties or replicating the attractive interest rate on the initial mortgage.
Lifetime mortgages attract no payments with interest rolled over and repaid with capital when the property is eventually sold.
As there are no regular payments to be made, there is no need for an affordability test. The minimum age for a lifetime mortgage tends to be around 55.
Home Reversion Plan
The criteria for a home reversion plan are similar to lifetime mortgages as they are targeted towards older homeowners. You basically sell a share of your property to a home reversion company, but unfortunately, this is at a submarket rate.
When the property is sold, they will receive a percentage of proceeds based on their share of the property.
There are numerous reasons why you may look towards an equity mortgage with a secondary charge as opposed to a simple refinancing.
In order to gain approval for an equity mortgage, there would need to be a significant degree of equity in your property, leaving a buffer between combined outstanding mortgages and the property value.
Equity release is becoming a more competitive market as life expectancy improves, working lives are extended, and the cost of living continues to rise.
How Can Equity Tree Help?
Here at Equity Tree, we have partnered with some of the UK’s leading Equity Release broker companies.
They have already helped thousands of people release equity already, and they can do the same for you.
Choosing an independent adviser means they won’t recommend a scheme unless they are sure it is in your best interests. Their advice is also regulated by the FCA, which gives you an additional layer of protection.
If you would like to speak to one of these equity release companies, click on the below and answer the questions.