What is equity release?
If you are aged 55 or over, it may be possible for you to access money that is tied up in your home. Whether through a tax-free lump sum, flexible borrowing over time or a combination of the two, equity release can offer a realistic option for those who find themselves in need of a cash injection in later life. The potential uses of the money raised are far-reaching and can include things such as home improvements, managing debt or supplementing your retirement income.
Equity release may sound like an ideal solution for property owners looking for a little extra cash, but it does come with some very significant drawbacks. As with any financial decision, it’s important to consider all of the available options before taking action and equity release is no different.
Read on to learn more about it, how it could work for you and why it’s not suitable for everyone.
What is equity in a house?
In simple terms, equity is the value of the proportion of your house that you own. Your equity equates to the deposit paid towards the purchase of your property, along with any of your mortgage that has been paid off. Once any borrowing secured against your property has been paid off, your equity will equal 100% of its market value.
How does equity release work?
Although they come under the same overarching bracket of equity release’ there are two quite different forms of financial products that can allow over 55s to access the equity in their homes. The two major varieties are known as a ‘lifetime mortgage’ and a ‘home reversion plan’, both of which are aimed at people in different situations and with distinct needs.
Perhaps the most common form of equity release is a lifetime mortgage. This option is available to those over 55 years old and essentially involves taking out a loan at a fixed or capped interest rate that is secured against your home. In most cases, this will not need to be repaid until you pass on or move into a long-term care setting. By borrowing in this way, you can access some of the wealth that you have invested in purchasing your home whilst continuing to live there. In some cases, it may even be possible for a borrower to ring-fence some of their property’s value as an inheritance for family members.
There are also two main variants of a lifetime mortgage, namely a lump sum lifetime mortgage and a drawdown lifetime mortgage. Anybody considering equity release by way of a lump sum lifetime mortgage should keep in mind that the debt can build quite rapidly due to the fact that no repayments are being made.
By contrast, a drawdown lifetime mortgage allows borrowers to repay the interest with some providers even allowing for a portion of the capital borrowed to be repaid to reduce the overall cost. By borrowing in this way, you can release money from your property at a steadier rate over time, up to a pre-agreed limit. This means that the interest you are charged is for the amount you take out instead of the total sum available.
Home Reversion Plan
Home Reversion Plans are available only to those homeowners over 65 years old and involve selling some or all of your home to a home reversion provider. The provider will pay a tax-free lump sum or series of ongoing payments in exchange for a portion of your home – although the total amount paid will often be below the market value of the property. You may continue to live in the house until your death, but after this time the property will be sold and the proceeds split between your estate and the lender dependent on their share. As home reversion providers purchase a share of your property, they stand to make a significant gain on their investment if the property’s value increases after the plan has been taken out.
To give an example, a home reversion plan might look something like selling a 50% share in a £300,000 property in exchange for a lump sum of £80,000. This is clearly well below what the share is actually worth (£150,000) but the trade-off is for the convenience of having tax-free cash in your pocket at the time the plan is taken out. When the house is eventually sold after your death, say for £400,000, the lender would pocket £200,000 for their 50% share. Lenders sometimes have to wait decades between issuing a home reversion plan and the property being sold, which goes some way to explaining why the sum offered is below the market rate.
How much does an equity release cost?
Releasing equity from your home can come with interest rates that are higher than standard mortgages. A lifetime mortgage equity release typically comes with an interest rate of around 5%, although some providers may offer rates as low as 3%. Whilst the rates charged against lifetime mortgages have been falling for some time, they remain considerably higher than a standard mortgage.
If you are not making monthly repayments on a lifetime mortgage, the cost for your estate after your death can be substantial. This is because interest will continue to accrue throughout the life of the mortgage, often without any repayment being made to reduce the sum owed. By way of example, if you were to borrow £30,000 against a £200,000 home with a rate of 5% at age 60, the amount your estate owes will have doubled to £60,000 by the time you reach 80.
In addition to the cost accrued through interest, getting an equity release in the first place does not always come cheap. Arrangement fees that cover things like legal work, application fees and the costs of hiring a surveyor often range between £1,500 and £3,000. You can get a more informed idea of what releasing equity from your home would cost based on your own circumstances by using an equity release calculator – many of which are available for free online
Is equity release a bad idea? What’s the catch?
As with any financial decision, releasing equity is not suitable for everybody and it comes with its own unique downsides to go along with the benefits of accessing money in this way. Equity release can provide a much needed financial boost in certain circumstances but can significantly affect what is received by any relatives who are set to inherit your home once you pass. It’s important to take qualified financial advice before making any decision and finding a provider that is authorised and regulated by the Financial Conduct Authority (FCA) and a member of the Equity Release Council may help to put your mind at ease.
The bottom line is that equity release does have future financial implications. There’s no ‘catch’ and it’s impossible to say whether it is a good or bad idea without looking at a person’s individual circumstances.
Can you pay back equity release?
Yes – but it isn’t quite that straightforward. While it is often possible to repay an equity release, lifetime mortgage providers will often levy an early repayment charge, which could be costly. For those who want to end a home revision plan early, you will normally be required to buy back the share of your home that you previously sold. The way paying back works varies from provider to provider and borrowers will be better placed to decide after taking financial advice.
What is an equity release advisor?
An advisor can help to guide you through the steps and options involved before you take the plunge. Deciding to go ahead with equity release is a big decision and getting professional financial advice can help to not only ensure you are dealing with a reputable provider but also to make sure that any particular scheme is right for you.