How does equity release work?
Perhaps this situation sounds familiar to you. As house values have risen over the last few decades, many over 55s have found themselves with considerable equity in their homes, but have been unable to access this money.
Meanwhile, in recent years pension returns have often dwindled, leaving many older people looking for ways to use their equity to fund their retirement.
This could leave you wondering how best to manage your future. One simple option is to sell your house and move into a smaller and cheaper property, otherwise known as ‘downsizing’. However, recent research showed that the majority of us would prefer to continue to live in our homes rather than downsize.
You may have heard about equity release. So would it be appropriate for you?
4 out of 5 homeowners would rather stay in their homes than downsize[i]
Equity release schemes offer a way to access the money that’s locked away in bricks and mortar without moving home. They are essentially loans which allow you to ‘release’ some or all of the equity in your home in the form of a tax-free lump sum, or a monthly income, while continuing to live in your house. See some examples below of the amount of equity you could release:
Is equity release a bad idea?
You may have read mixed reviews about equity release. In recent years, there have been a number of changes to many equity release products to provide greater flexibility and enhance the protection they provide.
Most equity release schemes now have a No Negative Equity Guarantee (NNEG). This means your lender, rather than you, would take the financial hit if when your house is finally sold, your outstanding debt is more than the value of your home.
In addition, many equity release lifetime mortgages also now allow you to pay off some of the interest during the course of the loan, while others also offer the option to ‘ring-fence’ some of the value of your property as an inheritance.
Nevertheless, before you enter into any kind of equity release agreement, it’s wise to take independent financial advice, and look at cheaper alternatives like downsizing or taking out a conventional mortgage. If your mortgage repayments are relatively low and you can afford to make higher monthly repayments remortgaging your home could be a good option, as interest rates for equity release are higher than residential mortgages.
Lenders are increasingly offering a wider range of options that have been specifically designed for the later life needs of older borrowers. So make sure you look at what is available and consider if taking independent financial advice may help you decide.
What is equity?
Equity is the difference between the current market value of your house, and your outstanding mortgage balance. In essence, how much of your home you actually own. For example, if your outstanding mortgage balance is £150,000 and the current market value of your house is £200,000, you have £50,000 equity in the property.
Am I eligible for equity release?
To be eligible for equity release you will normally need to be aged over 55 (65 for a home reversion scheme) and a homeowner with a home in the UK worth at least £70,000. Other factors that lenders will take into consideration are the type of property, your age and your health.
What kinds of equity release schemes are there?
There are two types of equity release, lifetime mortgages and home reversion plans, both of which are ways to release equity and stay in your home.
Lifetime mortgages have become the most popular type of equity release scheme in recent years. A lifetime mortgage is a loan secured against your home which will provide you with a tax-free lump sum, or regular monthly payments (often referred to as a drawdown lifetime mortgage).
With this form of equity release there are no monthly payments to make and you retain 100% ownership of your home. Instead the interest on the mortgage is compounded, or ‘rolled up’, over the term of the loan. The mortgage and compound interest are repaid when you sell your home, go into long-term care, or pass on.
With a home reversion plan, you sell all or part of your home to the provider at less than its market value, in return for a tax-free cash lump sum or regular income. Meanwhile, you continue to live in your home, rent-free.
The difference between this and a lifetime mortgage is that you no longer own all of your home. On your death, or when you move into a care home, the reversion company gets its share of the proceeds from the sale of your home. Anything that’s left becomes part of your estate. This form of equity release can be expensive and only accounts for less than 1% of the equity release market.
What are the costs?
A typical interest rate for a lifetime mortgage is currently around 5%, but some are as low as 3%, which although mortgage rates are currently low, is still higher than most standard mortgage rates. This rate must be either fixed or, if variable, must have a ‘cap’ beyond which the rate is guaranteed not to rise during the term of the mortgage. Since the interest is compounded, in other words ‘rolled up’ into your overall debt, you end up paying interest on interest. You could easily find the amount you owe doubling every 14 years!
There are also arrangement fees of between £1,500 to £3,000, legal fees, Early Repayment Charges and surveyor fees to take into account.
How long does equity release take?
The timescale for a lifetime mortgage, assuming there are no issues with the legal paperwork, is 4-6 weeks, rising to 6-8 weeks for a home reversion plan.
What are the pros and cons?
- Access value that is tied up in your home to fund your retirement
- A tax-free lump sum or monthly payments
- Stay in your own home
- You can still move house
- Own 100% of your home
- Most schemes now offer a ‘no negative equity’ guarantee – this guarantees that even should house values fall, you will never owe more than the market value of your home and won’t leave your inheritors the problem of paying off the accumulated debt.
- As the interest is compounded you could end up owing more than you originally borrowed
- Having a lump sum in your bank could affect your eligibility for other state benefits
- It’s likely that there will be less for your family to inherit.
- Access value that’s tied up in your home to fund your retirement
- A tax-free lump sum
- Stay in your own home
- Retain a share of your home to pass on to loved ones.
- You won’t be the sole owner of your home
- You will only receive a maximum of 60% of the full market value of your home – in fact, you will often receive much less than this
- It’s likely that there will be less for your family to inherit
- Your home would usually need to be vacated very quickly after your death, at what will inevitably be an emotional and upsetting time for your family.
How much could I borrow?
With a lifetime mortgage, you can normally borrow up to 60% of the value of your property. This is dependent on your age, and the value of your property. Some lenders will release more to older borrowers, and will often also take your medical history into account.
It is worth bearing in mind that with a home reversion scheme you will normally only receive between 20% and 60% of the value of your home. Again, lenders will often offer you more the older you are. This is why this form of equity release accounts for only 1% of the market, with most borrowers opting for some form of lifetime mortgage.
Is equity release right for me?
Here's why equity release might be right for you:
- Your savings and any other sources of income won’t be enough to meet your retirement needs
- You have no beneficiaries or are not concerned about reducing what you can leave as an inheritance
- You can’t downsize, or would prefer not to
- You have received independent financial advice that this is the right option for you.
Reasons to consider other options
- You already have a financial plan for your retirement that meets your needs
- You would be happy to release money from your home by downsizing
- Leaving as much inheritance as possible to your family is a priority for you
- You have been advised against equity release.
The importance of getting independent advice
Equity release is a lifelong financial decision that can be expensive to get out of should you change your mind. Many schemes carry Early Repayment Penalties. This means it’s vital to take independent financial advice before committing to any kind of scheme.
A further way to protect yourself when choosing an adviser is to check that they are authorised and regulated by the Financial Conduct Authority.
You can do this by looking them up on the Financial Conduct Authority register. You should also check that they are a member of The Equity Release Council which will give you the reassurance of knowing they are specialists in equity release guidance and will help you to make the right decisions for you.
Don’t forget that there are other alternatives to lifetime mortgages and home reversion plans. Find out more about downsizing and other equity release options.
The information on this page was sourced between June - October 2020 and updated in April 2021. Information on this site does not constitute any form of advice, representation, or arrangement by us and you take full responsibility for making (or refraining from making) any specific investment or other decisions. You should take independent financial advice from an adviser who is registered by the Financial Conduct Authority.
[i] Source: Mortgage Finance Gazette, Feb 2020