Remortgaging can be a tremendous way to pay off existing debts, increase your disposable income and ace the affordability test that’s conducted by all mortgage lenders.
In addition, it boosts your credit-worthiness when all your debts show as settled on your credit report.
Like everything in life though – if it sounds too good to be true, it probably is. That can be the case, but often, it’s not as clear cut. This page will help you understand exactly how a remortgage works - before you jump in feet first and agree to terms you’re vague on.
It’s because of the attractive interest rates that remortgaging works. It removes the high interest fees, such as a 29.9% APR on credit cards and store cards and moves them onto a lower interest loan, saving significantly every month.
Emphasis cannot be placed strongly enough on lowering your expenditure. When we say eliminate bad debts, what we really mean is making the bad debts good again. Like it was when you first took finance for whatever was bought.
It was manageable and that’s why people choose to remortgage. To bring debts back to a manageable level, when you can make the payments every month on time, and not be living in the red wondering which creditor needs prioritised.
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Good debts are managed and provide a return in the long-term. Your home is an investment and must be treated as such. As long as the finance that’s secured against your home is kept in good standing, there’s access to the equity you hold in it.
Every payment you make towards your home brings you one step closer to being a 100% homeowner, when the entire property solely belongs to you. That’s when your lender has been paid in full and there’s no mortgage in place.
It removes the bad debts by making them manageable in one monthly payment. It’s the lowest interest loan available for debt consolidation. That said the equity released from your home can be used for anything you like.
It’s not only applicable to bad debt scenarios. If you’d like to spend on something luxurious, there’s nothing stopping equity release from helping you make that a reality.
The cash you’ve paid towards your home is yours, always will be and remortgaging just speeds up the process of accessing it without requiring you to downgrade to a lower priced property.
It’s a means to help you live within your means. After reading that last paragraph, you may be inclined to think that because you’ve always paid your mortgage on time, and never missed a payment, you’re sitting on a cash stock pile. That’s not the case.
Know the way every financial product, including savings accounts that are linked to stocks and shares, tell you the value may go up or down. That’s the same with your home. What you paid for your property is not what your property is worth.
You could have bought your home before the Millennium for £100,000, and today it’s valued at £114,000. The equity is based on today’s valuation.
Not the valuation when you bought it. If you’d paid £80,000 towards the existing mortgage, you’d have £34,000 available in equity.
Not the £20,000 outstanding on the mortgage. Your equity is today’s valuation price of your home, minus the payments you’ve made towards it.
Equity is worked out the same way for a property that’s dropped in value. Things don’t suddenly shift direction to keep things working in your favour. If the value of your home has dropped, so too does the amount of equity available.
Using that same example above of a property bought at £100,000, which today has dropped in value to £80,000, for which the amount paid is £80,000 you’d have zero equity, therefore no security for a security loan, at least using your property anyway.
Worst-case scenario is you get a valuation of your property to find out how much it’s worth today, and discover it’s fell below what’s outstanding on the mortgage. That’s known as negative equity and it’s a really bad situation to be in.
It’s possible to remortgage with bad debt because it’s the equity in your home that’s used as security. When you have equity, you have security. When you have zero equity, you have a problem.
When you have negative equity, you have more debt because the lender has provided you a home loan for more than the value of the property they’ve secured it against.
When you have negative equity, it’s difficult to get a secured loan, because essentially, you have nothing to secure the loan against.
And it’s worse for a lender because the fact is that if they secured a loan on your property, should they have to repossess, the only guarantee is they would lose because once the first charge mortgage is paid, there’d still be debt remaining.
This usually happens due to falling property prices. It can also happen if the home is in disrepair.
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The simplest way to understand equity is this:
If you sold your home tomorrow for a cash lump sum for the full market value, would you be able to pay off the mortgage?
What you should never do is take any type of secured loan acting in the faith that the property price will increase. The housing bubble has been and gone and left behind havoc in its wake.
In the aftermath of the 2008 financial collapse, the hard lesson was learned. People who used remortgaging and other types of secured loans, borrowed on the basis that house prices were rising, so surely the value of the home would too.
That didn’t happen and people were left in financial ruin. The bubble burst and lots of loans were secured on properties, with many being foreclosed on by the banks. The price of homes dropped, and so did the liquidity that homeowners once had.
While house prices are higher now and people do have equity available to release, it cannot be relied on for a certainty. The housing market fluctuates and each time it does, it affects the amount of equity you have.
When the media discuss housing markets, they tend to report on buyer’s markets and sellers markets. A buyer’s market is low housing prices, which translates to your home losing value.
A seller’s market is when buyers are competing for properties, driving house prices up during which time your home’s more likely to increase in value.
If you’re considering any type of secured loan, pay attention to the media reports about the housing market in your area. A buyer’s market is when to move. A seller’s market is probably not the best time to tinker with your mortgage.
A buyer’s housing market is great for investors but its poor performance for homeowners.
Homeowners interested in remortgaging, or taking out a secured loan based on equity are best to do so during a seller’s market when equity’s likely to be at its highest.
Markets cannot be predicted with any degree of accuracy so never rely on your home’s value increasing.
With an understanding of how home equity works for you, it’s time to learn how lenders use LTV to manage the risks associated with house price fluctuations.
They do this with LTV, which stands for a loan to value ratio, which are shown as a percentage with the letters LTV beside them or for a table, it’s a column indicating the number as a percentage.
The amount of LTV a mortgage product or secured loan has indicates how much equity you need in your home.
An 80% LTV means only 80% of your properties market value can be used as security. For remortgaging, you’d need to have paid at least 20% towards the properties price to hold 20% equity in the property. When you have, the other 80% could be released based on using your properties value as security.
The highest LTV available is mostly 95%. Rarely will lenders offer 100% LTV. The amount of LTV you can access for a remortgage is linked with your credit files. For those with negative entries reported, typically lenders will allow between 50-80% LTV, sometimes 90% depending on the lender.
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The lowest interest rates are extended to those with a great credit file, meaning all accounts in good standing, never missed payments, defaulted or anything negative. The credit report essentially reads like a dream customer.
When there are negative entries on the report, they indicate risk. Any risk is met with a higher rate of interest.
Risks are assessed by the weight of them so there are some that can be overlooked, others considered low risk, some medium risk, and a few are considered extremely high risk. Examples can include entries like CCJs, a DMP, an IVA, a bankruptcy filing, missed payments etc.
The more negative entries there are on your credit file, the riskier a borrower you present as. In terms of the amounts of equity you can release, it’s never the whole amount.
When you’re considered to have bad debt, and therefore a risk, the amount you need to leave untouched is higher. Typical LTV for bad debts with specialist lenders are around 80% and under. Select specialist lenders catering to bad credit applicants do consider 90% LTV, however, these are few.
To understand bad credit remortgaging better, using the typical LTV ratio of 80%, it would mean the following:
For a property that’s worth 100k, the maximum loan amount would be £80,000. An outstanding mortgage of £70,000 would mean you could only borrow a maximum of £10,000. The mortgage repayment tables shown here provide more illustrative examples using different rates.
What really matters though is this….
Would you be able to qualify for a debt consolidation remortgage?
Like all loans for consolidating debts, remortgages must go through an application process. Some lenders (mainly the mainstream lenders like the big four UK banks) will outright refuse to consider the application based on bad debts alone.
To help get approved, a lender that allows for equity to be used for raising capital to pay off bad debts should be used. These are called sub-prime lenders, and while it is easier to be approved using one, they are not equal in how they treat applications.
As discussed, LTV is used based on the level of risk. The level of risk is a matter of opinion only. Some lenders may consider a debt management plan to be an extremely high risk because an IVA could still be granted through legal action.
Another lender could view it entirely differently, deeming it to be a measure of responsible money management by the applicant with a debt management plan.
The opinion of each lenders risk level matters because it’s reflected in the amount of LTV offered. For you as the borrower, you want a good LTV ratio, because that’s a measure of a good deal for you. Additionally, the rate of interest needs to be favourable.
The standard LTV for debt consolidation is 80%. Should you require more than that, there are lenders willing to extend the LTV to 90%.
During the application process, a lender will want to know the reasons for the application. Debt consolidation is perfectly acceptable as are many other reasons. It’s the later part in the assessment process that requires a credit assessment to be carried out that’s of particular importance.
A credit assessment is a standard procedure for any financial product. This will require a search on your credit files, so your credit history and current credit score will be accessed by the lender. It’s based on what’s on your credit report that sways a lenders opinion on the level of risk your application presents.
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An adverse credit history does not rule you out of remortgaging. It’s only a reflection of potential risk. Instead of having your application refused, a specialist lender used to dealing with adverse credit will assess risks more prudently, and extend credit with alterations to standard terms.
This could be a lower LTV, or a higher interest rate. In most cases, it means they charge more for the loan to cover the level or risk they feel they are taking.
Every lender uses different lending criteria. The strictest have a policy of only accepting applicants with a clean credit history. Others are more relaxed to certain types of negative entries reported on credit files.
After the credit assessment, there’s then affordability criteria required. This part is evidence-based. Applicants must be able to prove their ability to repay. The majority of lenders will be satisfied lending no higher than 4x the annual income of your household. There are specialist lenders willing to raise that to 5x the household income.
Due to the various stages in the application process and lending criteria used by all lenders, it’s best to use an advisor. Ask him or her to calculate your affordability. They can then use the affordability criteria of different lenders and pair you with one they know you’d meet the affordability criteria of and the one with the best rates of interest at the time.
Remortgaging is the cheapest method for debt consolidation, however, in certain circumstances, it is best not used. This could be if you have a great rate on your existing mortgage, meaning it would make no financial sense to shift it.
If that were the case, there are other methods to borrow for debt consolidation. There are two alternative borrowing methods which are either a secured loan, or an unsecured loan – more details on each here.
Option 1: The secured loan
All secured loans have higher interest rates than mortgages. That’s a given because remortgaging is the cheapest method, so when that’s not an option, the next thing to consider is another type of secured loan.
These have limits which are based on LTV and your affordability. As they are secured though, you can still alter the repayment terms to take them over a long-term. Theoretically, you can borrow as much as you need to, within the limits of your LTV and affordability.
Expect interest rates to vary between 7% often up to 30%. The rate you’re offered is based on your credit assessment. If your credit reports are in bad shape, your interest will be toward the higher end.
Option 2: The unsecured loan
Interest rates are hiked because of the lack of security on offer to lenders. This is reflected in the interest rates which vary from 6% up to 50%, sometimes more. Credit assessments are done, just like they are for any type of financial product. Based on your credit assessment, if you’re thought to be high risk, your rate of interest will reflect that.
In terms of the repayment period, most unsecured loans are limited to a 7-year maximum term and have a maximum amount of borrowing restricted to £25,000. If you need to consolidate a large amount of debt, this option will have high monthly repayments because it needs repaid in 7-years, which will be more difficult when there is a high rate of interest applied to the unsecured loan.
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