Can Borrowing Against Your Home Clear Your Mortgage?
For homeowners approaching retirement and aged 55 or over, the idea of using equity release to clear an existing mortgage can sound like an obvious solutio
Most people this age have built up substantial equity in their property.
Likewise, as people retire, they often find that their mortgage is becoming harder and harder to manage, and selling your home simply is not an option.
So why not borrow against the property, use the money to pay off the mortgage and remain living in your home until you pass away or move into a care home?
This is what thousands of people up and down the country does. In fact, repaying an existing mortgage is one of the most common reasons why people consider opting for equity release.
However, when it comes to doing so, there is an important distinction to understand.
Equity release can be used to pay off your existing mortgage, but it does not clear your debt. It simply replaces one form of borrowing with another.
It is also important to understand that when you opt for a lifetime mortgage, interest will most likely be added to the amount you owe, rather than being paid each month.
Over a long period of time, this interest will compound and add to your overall loan amount. This total loan amount will need to be repaid once you pass away or move into a care home, when your house will be sold to repay the equity release loan.
Likewise, there is also no guarantee that every homeowner with a mortgage will qualify for an equity release loan.
Equity release lenders take a number of things into consideration, including your age, your property, your existing mortgage, the loan-to-value (LTV), your health and your property type as well the circumstances surrounding your home.
So, can borrowing against your home really clear your mortgage? The short answer is that yes, it can. However, it is more accurate to say that equity release can repay your existing mortgage and replace it with an equity release loan.
What exactly is equity release?
Equity release allows older homeowners over the age of 55 the chance to access some of the money that is tied up in their home without having to sell the home and move to another property [1].
The most common form of equity release is a lifetime mortgage. When it comes to this type of equity release, the loan is secured against your home.
You only have to repay the loan once you pass away or move into long-term care when the property will be sold [1].
The money can then be used for a variety of different purposes, including paying off an existing mortgage.
That can be particularly attractive to someone who has reached retirement age with an outstanding mortgage but no longer wants or is no longer able to pay off their mortgage in their retirement.
Can equity release pay off an existing mortgage?
Yes, equity release can be used to repay an existing residential mortgage if you qualify to do so.
This can be particularly useful when someone reaches retirement age with a mortgage still outstanding and wants to remove the pressure of having to pay off a mortgage each month.
If you qualified for an equity release loan, then some or all of the equity released could potentially be used to clear the mortgage. Anything left over could go to loved ones or home renovations.
It is important to remember that the equity release loan would still have to be repaid eventually, usually from the proceeds of selling the property once you pass away or move into a care home.
This is why it is important not to look at equity release as a way of becoming debt-free. Instead, it can be a way of moving or restructuring debt later in life.
The first thing to understand is that the existing mortgage normally has to be dealt with as part of the equity release process.
When assessing your eligibility, the equity release lender will look at the value of the property and the amount that needs to be borrowed.
If they think that you have enough equity tied up in your home, then the pre-existing mortgage will be paid first before the remainder gets sent to you.
This sounds straightforward, although the calculation can quickly become much more complicated when the existing mortgage is large in comparison to the property’s value. This is where the loan-to-value ratio becomes incredibly important.
What is the loan-to-value ratio?
Loan-to-value ratio, commonly referred to as the LTV, is the percentage of a property’s value represented by the amount being borrowed [2].
For example, if a house is worth £250,000 and someone wants to borrow £100,000 against that property, then the loan-to-value ratio sits at 40%.
Likewise, if they wanted to borrow £150,000, then the loan-to-value ratio would be 60% [2].
When it comes to equity release, the maximum loan-to-value ratio available is not necessarily the same as it would be with an ordinary mortgage or loan.
In fact, the amount someone can release through an equity release plan is influenced by a number of different factors, and not just the value of their home. This includes their age, the individual’s health, the type of property and the lender’s criteria.
Why a high LTV can prevent you from opting for equity release
One of the biggest misconceptions when it comes to equity release is that if you own a valuable house, then that means that you can simply borrow enough money against it to clear whatever pre-existing mortgage remains.
However, that is not the case. Equity release providers and lenders need to protect themselves against the possibility that the property will not be sold at a high value and that they will not get all of their money back.
Due to this, the percentage of the property they are prepared to lend can be relatively conservative compared to what you might initially think or calculate yourselves.
It is important to understand that you should not assume that you can borrow enough to cover the whole of your existing mortgage.
For example, a £200,000 property with a £100,000 mortgage means that you still owe 50% of the property’s value. If the maximum amount of equity that a lender is willing to release is 35%, then they will only be able to borrow a maximum of £70,000.
Why does age matter so much?
Equity release is designed for those aged 55 or over. For mainstream equity release plans, applicants generally need to be at least 55 years old, although exact minimum ages can differ between equity release providers.
Equity release providers put a minimum age on their loans because age can affect how much a provider is prepared to lend.
For example, someone in their mid-50s might be offered a lower maximum percentage of their property’s value than someone who is considerably older than them.
This is partly because the equity release provider is considering how long it will be until the loan can be repaid.
The longer the equity release plan continues, the longer there is for interest to accumulate which means that the more you will owe by the time your plan comes to an end.
What happens to your inheritance?
Inheritance is another major consideration when it comes to equity release. For many retirees, the family home represents their largest asset and happiest memories in life.
Taking out an equity release plan reduces the amount of equity remaining in that property, meaning that there might be considerably less money left for your next of kin when the property is eventually sold after you pass away or move into a care home.
Taking inheritance into consideration is important, but it is also important to understand that someone might find that enjoying more financial security and stability during their retirement years is more important than being able to leave the maximum amount possible in the way of inheritance.
What should you ask your adviser before using equity release to clear your mortgage?
If you are considering taking out an equity release loan, then there are a number of different questions that you should ask your equity release adviser, some of which are listed below fro you.
- How much equity can I actually borrow?
- What is my maximum loan-to-value ratio?
- Will the equity release loan completely repay my existing mortgage?
- Can I make any early voluntary repayments?
- What happens if I want to move home?
- What happens to my inheritance?
- Will my property qualify for equity release
Conclusion
Yes, you can use your equity release funds to pay off your pre-existing mortgage, although it is not quite as simple as it sounds.
For someone struggling with mortgage repayments in retirement, equity release can provide valuable breathing space, although it is important to understand that the mortgage debt has not disappeared. Instead, it has simply only ever been replaced by a new loan secured against the home.
As discussed, there are also a number of restrictions on how much you can borrow, which will be down to your loan-to-value ratio.
In order to determine your loan-to-value ratio, lenders will look at your age, the property’s restrictions and individual lender criteria to consider.
Remember, equity release is a long-term financial commitment, and whilst using your equity release loan to pay off your mortgage might be a short term solution, it might create a long-term debt which will need to be paid off once you pass away or move into a care home.
References
[1] https://www.equityreleasecouncil.com/what-is-equity-release/
