What is Equity?
A question we are regularly asked when talking to clients about IVAs is What is Equity?
For any homeowner thinking of entering into an IVA, this question is crucial, as understanding how the equity in your property might be affected by an IVA will, no doubt, be of grave concern.
What Is Equity?
Equity is the term used to describe the value a person would still retain if they sold their property and settled all outstanding loans and charges borrowed against it.
- Property Value – (Mortgage + Secured Loan) = Equity
Equity is, therefore, the value of ownership a person has in a property or asset.
Why is equity important in the insolvency process?
Understanding why equity plays such an important part in the insolvency process is essential if you hope to protect it.
Being one step ahead of your creditors will give you the advantage you need to protect yourself and your equity from any legal actions being planned against you.
Because, to a creditor, equity represents a valid target when faced with a homeowner who can't repay their debt.
Creditors' legal rights
Under the Consumer Credit Act 1974, unsecured creditors have the right to take legal action against someone who breaks the terms of their credit agreement.
There's a complex path through the Courts that must be followed but, ultimately, an unsecured creditor could make a homeowner bankrupt if they were unable to repay their debt.
This is significant, because understanding the extent to which a creditor could go in pursuit of an unpaid debt helps explain why an IVA must provide a better return to the creditor than they would receive through bankruptcy proceedings.
Offering to repay more through an IVA acts as a deterrent against bankruptcy action being taken by the creditor.
Please note: When a property is owned by more than one person, it is only the equity owned by the insolvent party that will be taken in to account and creditors can lay no claim upon it.
Any equity owned by the co-owner(s) will be protected and form no part of an insolvency process. For a clearer description of how equity within a jointly owned property will be calculated, please call 0800 088 7503.
Why is equity important in an IVA?
In order to qualify for an IVA the applicant must be 'insolvent'. This means their assets must have less value than their outstanding debts.
Therefore, if an IVA applicant owns enough equity in a property to cover the amount they owe, they won't qualify for the IVA on the grounds they are not insolvent.
But if the applicant owns less equity than their outstanding debt they will be insolvent and, as a result, the IVA will protect that equity from any legal action creditors might take.
What happens to my equity in an IVA.
A major advantage of the IVA over bankruptcy is that, under the terms of the IVA, only a limited amount of equity must be surrendered into the IVA.
This limit is capped at a maximum 85% of the property's value. Furthermore, there are other limitations on creditors expectations which relate to the costs of a re-mortgage and the term over which a re-mortgage can be taken.
But by far the most important factor limiting equity release is that of the Loan To Value (LTV) ratio for people in an IVA, caused by their damaged credit rating.
At present the highest available LTV for an IVA candidate is set at 50% LTV.
This means the most an IVA candidate could raise in borrowings against their property at present is only half the value of the property.
For example: If the existing mortgage is greater than half the value of the property, the equity could not be released which, in turn, would mean the equity would be beyond the reach of the creditors and would be safe.
The IVA equity clause
In situations such as that described above, the creditors would invoke the IVA equity clause.
This clause extends the IVA term for 12 months in the event that more than £5,000 equity exists in a property, but it can't be released for whatever reason.
What happens to my equity in bankruptcy?
If you are made bankrupt, control and ownership of all your assets is passed to the Official Receiver.
They are tasked with liquidating any equity, through a forced sale if necessary, to release the equity for the benefit of the creditors.
100% of the bankrupt's equity is taken, but equity owned by other parties is returned to them.
The final outcome will be less favorable for the creditors than you might think, as the Official Receiver costs are enormous.
So bankruptcy takes 100% of the equity yet pays creditors very little in return. No good for either party.