Equity Release – Is It Right For You?
If you’re over 55, equity release could help you access the money tied up in your home to boost disposable income, pay off the mortgage or treat your nearest and dearest to a ‘living inheritance’. Our straightforward guide is a great way to see if it could be suitable for you.
In this article:
- What is equity release?
- How does equity release work?
- Home Reversion
- Lifetime Mortgages
- How much does equity release cost?
- Equity release: the pitfalls
- Is releasing equity the right option?
- Alternatives to equity release
- Equity release jargon buster
What is equity release?
Equity release relates to a range of products that allow you to access cash (equity) that is currently tied up in your home. If you are over the age of 55, you can obtain the money you release either in several smaller amounts or one lump sum.
How does equity release work?
There are two types of equity release: home reversion and lifetime mortgage.
With a home reversion plan, you all or sell part of your home to a provider – such as Bridgewater or Newlife – for less than the market value in exchange for a lump sum or a regular income. There’s no interest to pay and you’re able to live in your home rent-free for the rest of your life. You may be able to buy back the share you sold at a later date but only at the full market value.
If you have sold all of your home using a home reversion scheme, the ownership of your home will be passed on to the home reversion provider when you die. However, if you have chosen to only sell a share of your home using a home reversion scheme, then a share of the property’s value can still be passed on as inheritance.
For example, if you’ve sold 40% of your home using a home reversion scheme, 40% of the property’s value will go to the provider when your house is sold after you pass on, and 60% will be added to your inheritance.
A lifetime mortgage is effectively a fixed-rate, long-term loan taken out against your home, with the cost covered by the eventual sale of your property.
This allows you to borrow a large sum of money secured against your property, so you can continue to live there and don’t have to completely sell up.
You’ll retain full ownership of your home and live there. When you die, or if you move into long-term care, the money obtained from selling your home is then used to pay off the loan and any remaining funds go to your beneficiaries.
There is a risk that the amount received from selling your house won’t cover the cost of the loan fully, in which case your beneficiaries would be liable to pay off the remaining amount, leaving them out of pocket. This is why lifetime mortgages which are approved by the Equity Release Council must offer a no-negative-equity guarantee.
Top tip: Make sure you choose a lifetime mortgage provider that is a member of the Equity Release Council. Members must offer a no-negative-equity guarantee, which means you’ll never have to pay back more than the value of your property at the end of the mortgage. But check double check and make sure it is clearly stated in the loan agreement.
You can borrow a large sum at the start of your loan term (e.g. £25, 000 all at once), or take smaller loan payments known as ‘draw-downs’ spread out over a number of years (e.g. £5,000 every 3 years for 15 years).
Interest is charged on the amount you’ve borrowed so you would accumulate less interest by opting for draw-down payments over a lump sum – see How much does equity release cost? below.
You can either pay off the interest regularly – this is called a interest-paying mortgage – or the interest can be added to the loan amount and paid when your house is sold – this is called a interest roll-up mortgage.
For example, you take out a Lifetime Mortgage of £45, 000 – with a fixed-rate of 7% – and then die 10 years later. A interest roll up mortgage would result in you owing the original value of your loan plus interest, which equates to £88,552.
(7% x £45,000 = £3,150 x 10 years = £31,500 + £45, 000 = £88,552).
If your house sells for £90, 000, then the lifetime mortgage would be paid up and £1,448 would be inherited by your beneficiaries. On the other hand, if you paid off the interest every year you would only owe £45,000 leaving another £45,000 to be inherited by your beneficiaries.
To work out what a Lifetime Mortgage would look like for you, use a reliable Lifetime Mortgage calculator like this one from Legal & General.
If you’re concerned about leaving an inheritance for your loved ones, you can ring-fence a part of your home. This means you can release equity while being confident a percentage of your home is protected and will be passed on to your children.
To find out more about Lifetime Mortgages, you can seek advice from the Money Advice Service.
How much does equity release cost?
Home reversion costs nothing up-front as lenders make their money when your house is sold. The amount you pay on a lifetime mortgage depends on what type you take out. For instance, a standard product that pays a lump sum will be more expensive than a draw-down mortgage where you receive the emoney in stages, as you need it.
Take a look at this example comparison for a couple in their seventies who release £50,000 from a house worth £250,000
|Standard Lifetime Mortgage @ 6.5%||Draw-down Lifetime Mortgage @ 6.5%|
|Amount borrowed against home||£50,000||£50,000|
|Money received||£50,000 up front||£20,000 up front, £10,000 after 4 years, £10,000 after 6 years, £10,000 after 9 years|
|Amount owed after 5 years||£68,504||£38,052|
|Amount owed after 10 years||£93,857||£75,649|
|Amount owed after 20 years||£176,182||£142,003|
Equity release: the pitfalls
The upside of equity release is obvious – a large cash amount that can be put to lots of good uses. But there are disadvantages too. Here are five pitfalls to be aware of.
1. High interest bills
As shown in the example above, interest can soon mount up. If you live for a long time after taking out the plan, the eventual amount you pay could exceed the value of your home. Most reputable equity release schemes offer a no-negative equity guarantee, but it still means that the entire value of your property might need to be used to repay the debt – meaning you may have little to nothing to pass on when you die.
A provider must offer a no-negative equity guarantee if they’d like to join the Equity Release Council. Check here to see if the provider you have in mind is a member.
2. Not benefiting from house price rises
If you choose a home reversion plan, you won’t benefit from a rise in the value of your house. So, if you sell a 45% stake, you or your family will only get 55% of future house price increases.
3. Limits on how much you can unlock
Your home may be worth a tidy sum, but that doesn’t necessarily mean you’ll be able to take out a similarly impressive amount. Usually the younger and healthier you are the less you can unlock. For example, an average borrower in their late 60s would typically be allowed to release 35% of their home’s value.
4. Hefty redemption penalties
Many equity release products have stiff redemption penalties. That means if you want to pay off a loan early, you’ll be hit with extra charges. It’s worth checking these out before you sign on the dotted line. A Daily Mail investigation in November 2018 discovered that charges can range from £125 to an astonishing £23,095.
5. Loss of benefits
Suddenly having access to a tax-free lump sum could affect your entitlement to means-tested state benefits. This includes pension credit, savings credit and even council tax benefit. Even if you can’t claim these benefits now, think carefully about whether they could be useful in the future.
Is releasing equity the right option?
Like any major financial decision, it’s vital to carefully research the pros and cons of equity release and seek advice where possible.
Equity release is a lifelong commitment. If your circumstances change, you may find your options seriously restricted.
Talk to a qualified independent financial advisor before you make a decision. Do your own research too – the government’s impartial Money Advice Service is a good place to start. As is the StepChange charity, which not only compares providers, but can also arrange an equity release deal for you through one of their StepChange Financial Solutions advisers.
Research alternatives to equity release (more on this below) and if you do decide to go ahead:
- Choose a draw-down scheme to give you cash as and when you need it. If you do go for the full lump sum, borrow the minimum amount you need
- If you can afford it, consider a scheme that allows you to make interest payments each month to reduce the final amount you pay
- Try to select a scheme with no early repayment charges
Alternatives to equity release
Equity release is one way to access a lump sum relatively quickly, but it’s certainly not the only option. Depending on your circumstances, there may well be others that are more suitable.
1. Unsecured loans
It’s worth considering an unsecured personal loan when looking to borrow a smaller sum. It may well work out cheaper as long as you can meet the repayments.
2. Mortgage extensions
If you haven’t paid off your mortgage by the time you retire, it’s worth checking whether your current lender might extend the term for another five or 10 years, giving you a useful lump sum that you can pay off from retirement income.
3. Retirement mortgages
Retirement interest-only mortgages, where you pay the interest but not the capital each month, are becoming more common. They’re certainly worth exploring as some don’t have a maximum age for applications, making them an interesting alternative to equity release.
If you need to release a substantial sum, selling your house and moving somewhere smaller could be an option. Of course, there will be associated costs with agent fees, removal costs and stamp duty to consider. But a smaller home could also be easier to manage and cheaper to run. To find out more take a look at our guide to property downsizing.
And, if you do decide to downsize, don’t forget that Good Move can help with a smoother sale – no chains, no agent or solicitor fees, no hassle.
Equity release jargon buster
As with all financial products, equity release has a host of terms that may be difficult to follow for the uninitiated. Our simple guide will make sure you’re fluent in no time:
Annual Percentage Rate, (sometimes referred to as the Effective APR). The yearly interest rate you have to pay on a loan.
The charge you may have to pay to your equity release provider for the admin involved.
Selling your home to buy a cheaper one. A common way to release some of the money tied up in your home.
Draw-down Lifetime Mortgage
A type of lifetime mortgage that allows you to release money as and when you need it, up to an agreed limit.
When compared with a standard lifetime mortgage the advantage is that interest only begins being charged once the money is released. However, the amount you owe will continue to grow as interest is applied on the amount borrowed.
Like all lifetime mortgages, draw-down mortgages are repaid when the last surviving borrower dies or moves into permanent long-term care.
Early Repayment Charge (ERC)
You can repay your lifetime mortgage at any time (either in cash, or by selling your home). The early repayment charge (or ERC) is the fee you often have to pay for the privilege.
The amount of your home that you own, above any mortgage that may still need to be paid off. For example, if you own your home outright, the equity you have is 100%.
Equity Release Council
The industry body for the equity release sector. They oversee operators and safeguard consumers.
Read more about the Equity Release Council here.
Equity Release Plan
A way of unlocking the money tied up in your home to help towards your retirement. There are two types: home reversion and lifetime mortgages. Usually available to those aged 55 or over who own a home worth over £70,000. Only available on your main residence, which must be in the UK. Other eligibility criteria vary between product providers.
Everything you own when you die (minus anything you owe) is known as your estate. By securing a loan on your home or selling off part of it, equity release reduces the value of your estate and what you can leave to family and friends.
A type of equity release plan where you sell part, or all, of your home to a reversion company in exchange for a lump sum. Effectively, you become a co-owner of your home but retain the right to live in it for the rest of your life. Note that the two figures can be quite different, so a lump sum equivalent to 30% of the current value of the house might be exchanged for 70% of the future value of the house when it’s sold. This can make home reversion an extremely expensive way to borrow money. You can end a plan early and buy your share back, but you’ll need to do it at full market value which could be a lot more than you sold it for.
Some equity release plans let you take your money as income rather than a lump sum. This could boost your regular pension income, while potentially lowering borrowing costs when compared to one up-front payment. However, you will still be paying compound interest, so as with all equity release schemes, this will reduce the value of your home when you pass it on.
Inheritance Protection Guarantee
If you’re keen to preserve a portion of your home’s value as part of an inheritance, you can ringfence it with an Inheritance Protection Guarantee. This will reduce the equity you can release from your home and may increase the interest rate charged.
The tax paid from the proceeds of your estate when you die. If the value of an estate exceeds £325,000, then tax is charged at 40%. However, there are exemptions for family members named as beneficiaries. A surviving spouse or civil partner does not have to pay, and the allowance of £325,000 for the deceased may also be carried over, meaning inheritance tax is only payable on estates worth more than £650,000, assuming no other property has been passed on to anybody else, such as children. Talking of whom, there is also an additional allowance available when a family home is passed down to the deceased person’s children.
Equity release plans run until the money is repaid, or until the last borrower moves into permanent long-term care or dies. Having a joint equity release plan is important because it means that your spouse or partner won’t have to move out of the home if they outlive you, or if you have to move into permanent long-term care.
The legal authority you have to stay in your home rent-free for the rest of your life (or until you move in to permanent long-term care) under the terms of an equity release plan.
The most popular form of equity release, where you unlock a percentage of your home’s value as a lump sum or in stages, secured against the property. The percentage you can release will depend on your age – generally the older you are, the more you can access.
Compound interest is charged on the amount you release – so the amount you owe increases over time. The mortgage and interest are repaid on death, or if you move into permanent long-term care. There are ways to reduce the interest you pay: for instance, some providers allow you to make regular repayments.
The percentage of the property’s value that you owe the equity release company. You can only borrow up to a certain Loan to Value (e.g. 40%), and, as interest is added to a lifetime mortgage the percentage you owe may actually increase over time, especially if house price growth is slow.
The amount you receive up-front from the equity release plan. Most allow you to take your money as one total, tax-free payment.
No Negative Equity Guarantee
Almost all lifetime mortgages include this feature – which ensures that neither you nor your loved ones will ever owe more than 100% of your property’s value. Check whether your provider belongs to the Equity Release Council as all members offer this guarantee as standard.
The Financial Conduct Authority (FCA) requires financial companies to present quotes to their customers in this straightforward format to aid customer understanding. Sometimes called a Key Facts Illustration.
All equity release plans offered by Equity Release Council members are portable – so you can take them with you when you move home with no penalty as long as the new property meets the provider’s lending criteria.