If you are short of savings but have cash tied up in your home that you’d like to be able to make use of, one way to do so (if you’re over 55) is through an equity release product. In effect it means you’re taking out a loan against part of the value of your property.
The equity release market has grown rapidly in the UK. Some £3.89 billion of property wealth was released this way in 2020, compared with just £2.15 billion five years earlier, according to the Equity Release Council (ERC).
Equity release may sound an attractive idea if you need money and don’t want to downsize. You don’t have to repay any money during your lifetime, and you have the right to remain in the property for life, without risk of repossession.
But these schemes, although they are more flexible than they used to be, are risky and can prove extremely expensive over the longer term, so you do need to understand how they work and how they could impact on the property value left for your family.
There are two types of equity release. Let's look at how they work:
Lifetime Mortgages
The more popular equity release option is a lifetime mortgage, with a record 500-plus products now on the market, according to Moneyfacts.
These enable you to borrow a chunk - usually up to 60% - of your home’s value (generally, the older you are when you take out the lifetime mortgage, the more you can borrow).
Interest rates are typically higher than conventional mortgage rates, but will be fixed or capped for the life of the loan. The ERC says that in January 2021, almost three in five equity release plans charge an interest rate below 4%, with a quarter of products on less than 3%.
You retain ownership of the property, and you don’t usually have to pay interest on the loan during your lifetime. Instead, interest rolls up and becomes part of the loan, so interest becomes payable on a progressively larger capital sum.
To put that into context, if you borrowed a £40,000 lump sum at 5% interest, then after the first year you would pay £2,000 interest. This would be added to the initial capital, so in the second year you’d pay 5% interest on £42,000, which is £2,100; and so on. After 10 years your debt would have grown to just over £65,000. Your debt would double roughly every 14 years.
However, in many cases you’ll have the option of repaying capital early without penalty (available on almost two thirds of lifetime mortgage products, according to the ERC), or making monthly or ad hoc interest payments (30% of products).
Moreover, even if you’re not keen on making repayments to keep interest charges and the final loan value down, it is possible to reduce the interest payable.
Rather than taking a single lump sum, you can choose a drawdown scheme whereby you only withdraw cash as you need it, and pay interest only on what has been drawn down.
Importantly, all lifetime mortgages from ERC members have a ‘no negative equity’ guarantee. This means that when your property comes to be sold and the agent and legal fees have been paid, you and your estate are not liable for the balance if the amount left doesn’t cover the outstanding loan.
Home rRversion
With a home reversion plan you sell part or all of the property to the provider, at well below the market price - typically between 30% and 60% of the property’s market value. The older you are when you start the plan, the better the deal will be. The plan provider then owns that portion of the property. In return you receive a lump sum or regular payments and have the right to stay in the home, rent-free, until you die or need to go into care. But you will have the responsibility of maintenance.
What to Consider Before Opting for Equity Release
Equity release will likely impact your ability to leave an inheritance. If that’s important, talk to your family and other beneficiaries of your will before doing anything.
Be aware that there are also alternatives that might work better for you. You could consider selling your home, buying something smaller or renting a property, and living off the spare capital.
Alternatively, you could look at using a retirement interest-only mortgage, which is a relatively new product similar to equity release but with some important differences.
If you decide to go ahead with equity release, use a plan from an Equity Release Council member, as this guarantees clear product safeguards.
There will be charges attached to the setting up of an equity release plan, including valuation, legal and arrangement fees, typically totalling £1500 to £3000. Make sure you’ve budgeted for them.
Money released by an equity release plan is tax-free (though if you invest or bank it, you may pay tax on any growth). Equity release may, however, affect your eligibility for means-tested state benefits and also affect any funding you might receive for long-term care services.
You’ll also have to think about how you’re going to generate a sustainable income from any lump sum you receive.
Equity release plans are not to be entered into lightly. It’s important to take independent financial advice.
