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 concern.

What Is Equity?

Equity is the term used to describe the amount of money 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 protracted route through the Courts that a creditor must follow but, ultimately, an unsecured creditor could potentially bankrupt a homeowner if they were unable or unwilling to take the necessary action needed to repay their debt.

This is significant, because understanding the potential threat posed by an unpaid creditor helps explain the logic behind most IVA proposals.

A person offering to repay more through an IVA in comparison to the amount a creditor could hope to generate by bankrupting that person has a strong and, usually, convincing argument.

Please note:
It is important to understand that a creditor can only show an interest in the equity share of the person entering the IVA.
When a property is owned by more than one person, it is only the equity owned by the IVA applicant that will be taken in to account.
Any equity owned by the co-owner(s) will be protected and, therefore, form no part of an IVA process.

Why is equity important in an IVA?

In order to qualify for an IVA the applicant must be considered 'insolvent'.

One of the tests used to determine whether an individual is insolvent is to measure the value of their assets against the value of their outstanding debts.

So, if an IVA applicant owns substantial levels of equity when compared to the amount they owe in unsecured debts, the viability of the IVA can be undermine.

For this reason it's important to make sure that those thinking of entering an IVA use a realistic market appraisal for the valuation of their property, as opposed to an inflated valuation.

Using a realistic market valuation will lower the estimated equity value and, thus, strengthen the chances of an IVA being a viable solution.

What happens to my equity in an IVA.

Towards the end of an IVA, homeowners will be expected to try and release some of their equity into the IVA for the benefit of their creditors.

However, under the IVA's terms and conditions, limitations are set on the equity release process, to curb creditors' expectations.

The equity clause of an IVA stipulates that homeowners must try to release up to a maximum of 85% of the property's value.

This could be a daunting prospect in some scenarios but, fortunately, limits are in place to restrict the maximum monthly cost of the new finance to being only 50% of the IVA contributions and, also to restrict the term over which the finance can be taken.

These two restricting factors limit the possibility of an IVA applicant being expected to borrow more than they can afford, or for a longer repayment term than is fair.

Borrowing is also limited as a result of having a damaged credit rating, as a consequence of being in the IVA itself, and potential mortgage lenders will look to reduce their risks by restricting what they will lend to someone in an IVA.

At time of writing (Jan 2016) the highest Loan To Value mortgage available to someone in an IVA is 75%.

This means the most someone currently in an IVA could raise against their property is only three quarters of the property's value. So, if their existing mortgage is greater than 75% of the property's value, no equity could be released.

The IVA equity clause

In situations such as that described above, where the equity in a property can't be released, the Insolvency Practitioner 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?

It's worth pointing out that, in contrast, if you are made bankrupt, control and ownership of all your assets is passed to the Official Receiver.

The Official Receiver will then appoint a Trustee who will be tasked with generating any equity you own in any manner they can. Ultimately, and in cases of none compliance, the Trustee has the power to liquidate equity via a forced sale.

In bankruptcy 100% of your equity is taken from you to off set against bankruptcy costs and your unsecured debts, but equity owned by other parties is returned to them.

However, even though the Trustee takes all of your equity, the final outcome to your creditors will be less favorable than you might think, as the Official Receiver and Trustee's costs are usually enormous.

In fact most bankruptcy cases pay creditors only a very small return.

In accordance with the Financial Conduct Authority's guidance, please follow this link if you would like to read a free guide about In Debt - Dealing with your creditors
To find out more about managing your money and getting free debt advice, visit Money Advice Service , an independent service set up to help people manage their money.

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