Equity release, sometimes known as a “lifetime mortgage” or a “home reversion plan,” is a method of releasing money from your property without making any monthly payments.
We’ll take a closer look at how equity release works in this article, including:
- What equity release is
- Who can use equity release/lifetime mortgages
- Different types of equity release
- The reasons people choose to release equity from their home
- Some pros and cons of an equity release product
We’ll also take a look at why equity release has had a bad reputation – as well as the measures taken by the sector to ensure that those releasing equity are treated fairly.
What is equity release?
Equity release is a method for people aged 55 or older to release funds from their property without making any monthly payments.
Instead of making monthly payments, the equity release company will own the property when the individual passes away or moves into permanent residential care. Some equity release products let people take a single large tax-free lump sum from their home’s value. Other products provide regular smaller sums to owners Some products offer a mix – with a lump sum and regular payments.
There are several equity release solutions on the market, each tailored to a certain demographic.
Before you decide to release equity from your home, you must get independent financial advice.
Who can release equity?
You must be at least 55 years old to qualify for equity release products, and you must own the property you want to get out of debt. Some programs demand that you are at least 60 years old.
You don’t have to own the property outright. If you still owe money on an outstanding mortgage and want to release some of your funds, or if you want to pay off your existing mortgage with the cash that would be available through a lifetime mortgage, you may do so.
The amount of money you can borrow from your equity usually relies on two things: how old you are and the worth of your house.
Types of equity release
There are two main categories of equity release products on the market:
- Lifetime mortgages
- Home reversion plans
Let’s take a look at each in more detail.
A lifetime mortgage
A Lifetime mortgage is a loan secured against your home. They are the most popular form of equity release and are generally available to people over the age of 55.
These loans will generally allow you to borrow a portion of the value of your house at a ‘capped’ or ‘fixed’ interest rate. This means that the interest rate you’ll be charged for borrowing money will never rise above a certain percentage.
A lifetime mortgage allows you to take your money either as a lump sum or in smaller increments, called “drawdown.”
If you’re not going to touch a lump sum immediately, it’s often better to go with a drawdown option. This is because you’ll only be charged interest on the money you’ve already taken out, rather than the entire amount of money.
A lifetime mortgage gives you the right to live in your house until death or long-term care. The lifetime mortgage provider takes complete ownership of the property as payment for the loan at this point.
A home reversion plan
Selling a portion of your house below market value is known as a home reversion plan. These services are typically offered to individuals over the age of 65.
Home reversion is similar to a lifetime mortgage in that you can live in your home until you die or go into long-term care. The main difference is that, with a home reversion plan, the provider sells their share of your property instead of taking full possession.
The lender makes money after the contract by selling their portion of your property for the full market value rather than charging you interest. With a home reversion plan, you’ll be able to take a lump sum, make a series of smaller payments when you need them, or do both – with an initial lump sum followed by additional payments as they’re required.
How does interest on equity release work?
Because you’re not paying off equity release loans, it’s easy to be perplexed as to why lenders charge interest.
When you investigate how most people use equity release, it becomes less complicated. The average person will only borrow 20% of the total value of their home as a lump sum or through drawdown payments.
If you borrow against your home using an equity release product, the provider will become the owner of your property when you die. They will then sell the property to recover the amount borrowed and any interest charged.
Anything extra that they are not owed will become part of your estate, which is often given as an inheritance to loved ones.
Why do people choose equity release?
There are numerous reasons why individuals might choose to sell some or all of their house equity.
Pay off existing debts
Many individuals retire with outstanding debts, which is a concern for many individuals when their working salary ends.
Reducing or eliminating debt later in life by releasing equity from your property leaves you with lower monthly expenses and less financial stress.
Some other possible options for equity release include an IVA or different types of debt solutions.
Make home improvements
Many people use equity release products to make improve their homes before retirement, as they anticipate spending more time there.
Increase disposable income
If you’re worried that your retirement income won’t cover the lifestyle you want, consider using a drawdown equity release product. This will help to increase your income when additional funds are needed.
Help family or friends
Before they pass away, many individuals choose to release equity from a house to give inheritance to family or friends.
This might be appealing to individuals who want to assist their younger family members to get on the property ladder or help pay for university tuition or other living expenses.
A new car
Many older individuals cannot afford to purchase a new car, which is often a significant investment.
If you sell some of the equity in your home, the lump sum could pay for a new vehicle in cash – or provide a down payment for your next car.
How much does equity release cost?
With equity release, you’ll face some costs upfront and others as ongoing interest payments.
Upfront costs
The upfront expenses are comparable to those needed when obtaining a standard mortgage on a property, including arrangement charges, property survey and valuation expenditures, as well as the legal counsel you’ll require from a conveyancing solicitor.
Generally, these costs amount to £1,500 or £3,000 depending on your product choice.
Interest
Although the rate you’ll pay for an equity release plan will vary, it’s usually between 3% and 5%.
This figure is often much higher than standard mortgages and can build up quite quickly.
This is down to ‘compound interest’ – meaning you’ll pay interest on both the full amount outstanding and any existing interest.
Someone who borrows £20,000 at 5.1% for a property worth £120,000 in Martin Lewis’s MoneySavingExpert example would see the amount owing double every 14 years.
Consequently, if that person passed away at 74, their family would owe £40,000. However, if they lived to be 88 years old, the amount owed would double to £80,000.
What are the pros and cons of an equity release loan?
All financial products, including lifetimes mortgages and other equity release plans, have both advantages and disadvantages.
Pros
You get to stay in your home
You can borrow as much money as you want, and no matter how long you live, you can always stay in your property.
There are no monthly payments needed
You are not required to make any repayment to increase an inheritance that may be left after you pass away.
You’ll never owe more than your home is worth
Lenders following Equity Release Council regulations provide a ‘negative equity guarantee,’ meaning you will never owe more than your home is worth. If there is any remaining balance at the end of the agreement, it will be written off.
You can access money when you need it
With equity release, you can have access to the funds that are being put into your home- meaning you now have money to spend on what matters most to you.
You may avoid inheritance tax
Equity release may allow you to gift money to loved ones without them having to pay inheritance tax, as opposed to if the money was distributed through your will and estate.
Before making any decisions, it is important to speak with a professional about equity release and how it may affect inheritance tax and estate planning.
Cons
Your debt will increase as interest is added
Your debt may grow substantially the longer you live if it’s based on compound interest, as it does with lifetime mortgage and home reversion plans. This will not have a detrimental influence on you since you won’t be required to make payments or fall into negative equity. If you’re hoping to leave some money for your family after selling your house, this might prevent that from happening.
Your benefits could be affected
If you receive any means-tested benefits, your eligibility may be affected by the additional cash you have access to. This isn’t just relevant for present-day benefits. You should consider this with an approved equity release adviser before deciding if you can get benefits in the future – for example, Universal Credit or pension credit.
You might have to pay an early repayment charge or exit fees
Although it is possible to settle both lifetime mortgages and home reversion plans, it may be expensive. If you settle a lifetime mortgage, there will likely be significant interest costs incurred. Also, if you want to buy back the share of your house that was sold as part of a home reversion plan, understand that you’ll purchase it at the current market value–not the reduced price from when it was first sold.
You won’t be able to leave your home as an inheritance
If you would like to bequeath your home to future generations, this will no longer be possible if you use any type of equity-release product.
This does not mean that you cannot leave anything behind upon death – it simply means that the lender will take control of your home when you die or go into long-term care. Any money leftover after the lifetime mortgage is paid off will become part of your estate though – so there is still a possibility that you can leave an inheritance.
If you want to ascertain how much of an inheritance you can leave, speak with a financial advisor and use an equity release calculator.
There are set up fees
initial fees must be paid when using equity-release financial products, similar to a typical mortgage.
Essentially, you’re looking at spending anywhere from £1,500 to £3,000 on legal fees, along with the cost of a surveyor and valuation professional, as well as additional admin and paperwork fees.
You won’t be able to take any further loans against your property
A home may be used as security for some financial products, but this will not be the case if you have a lifetime mortgage secured against it.
