Sometimes referred to as a ‘lifetime mortgage’ or a ‘home reversion plan’ – equity release is a way of freeing up money that’s built up in your home without any monthly repayments.
In this guide, we’ll take a detailed look at how equity release works, 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 sometimes had a bad reputation – along with the steps that the industry has taken to make sure people releasing equity are treated fairly.
What is equity release?
Equity release is a way for people aged 55 or over to release money from a property they own without having to make any monthly repayments.
Instead of making monthly payments, ownership of the property is passed to the equity release company when the individual passes away or moves into permanent residential care.
Some equity release products let the person take a single large tax-free lump sum from the value of their home. Other products give the owner regular smaller sums. Some products offer a mix – with a lump sum and regular payments.
There are lots of equity release products on the market, each designed for people with slightly different requirements.
Although we’ll go into some detail here, choosing to release equity from your home is a significant decision – so it’s important that you get independent financial advice before you make your mind up. We’ll explain where you can get equity release advice later in this guide.
Who can release equity?
To qualify for an equity release products, you must be at least 55 years old or above and own the property you’re planning to release equity from. Some products require you to be 60 years old or above.
You don’t necessarily have to own the property outright. If you have an outstanding existing mortgage, you may still be able to release some of the money you have tied up in your home – or pay off your current mortgage with the funds that would come from a lifetime mortgage.
Generally, the amount you can release will depend on your age and the value of your home.
Types of equity release
There are lots of different equity release products on the market – but generally they’ll fall into one of two categories. They are:
- Lifetime mortgages
- Home reversion plans
Let’s take a look at each in more detail.
A lifetime mortgage
Lifetime mortgages are a loan taken against your property. They most commonly used kind of equity release and are usually available for people aged 55 and above.
These products will usually let you borrow some of the value of your home at a ‘capped’ or ‘fixed’ interest rate. This means the interest that you’re charged for borrowing the money will never increase beyond a certain percentage.
With a lifetime mortgage you can take your money as a lump sum, or in smaller chunks as it’s needed. If you decide on taking smaller amounts, you’ll find this is usually called a ‘drawdown’ plan.
If a lump sum is only going to sit in a person’s bank until they use it, choosing a drawdown option often works out better – as you’re only charged interest on the money you’ve actually taken, not the money you’re yet to take.
A lifetime mortgage lets you live in your home until you die or are taken into permanent care. At this stage, the lifetime mortgage provider takes full ownership of your house as repayment for the loan.
A home reversion plan
A home reversion plan involves selling a portion of your home for less than the current market value. These products are generally available for people aged 65 and over.
Like a lifetime mortgage, you’ll be able to carry on living in your home until you die or go into long-term care. However, rather than take full possession of your home at this point, a home reversion provider instead sells their share in your home.
Rather than making money by charging you interest, the provider makes money at the end of the deal by selling their portion of your home at the full market value.
With a home reversion plan, you’ll be able to take a lump sum, a series of smaller sums when you need them, or a mixture of both – an initial lump sum followed by smaller payments as they’re needed.
How does interest on equity release work?
Since you’re not making any repayments towards equity release products, it can sometimes feel a little confusing why lenders charge interest.
However, when you look at how most people use equity release, it becomes clearer.
Equity release lenders will usually offer a maximum of 60% of the value of your home as a lump sum or drawdown payments – but some people only borrow 20%.
No matter how much you borrow against your home, the equity release product provider will become the owner of your property when you die. Then, they will sell the home to recover the amount you have borrowed and the interest they have charged.
Any money above and beyond what they are owed will then become part of your estate – often as inheritance for loved ones.
Why do people choose equity release?
There are lots of reasons why people choose to release some – or all – of the equity in their home.
Pay off existing debts
Lots of people go into retirement with outstanding debts – which for many people can be a worry when a working wage stops.
Releasing the equity from a property to pay off this debt means reducing outgoings and less financial pressure in older age.
Make home improvements
Retirement is likely to see you spending more time in your home – so many people use an equity release product to make their property as comfortable and appealing as possible.
Increase disposable income
If your retirement income doesn’t feel like it will be enough for the lifestyle you have in mind, using a drawdown equity release product can help to boost that income when additional funds are required.
Help family or friends
Many people decide to free up equity from a property to provide some inheritance for family or friends before they pass away.
This might appeal to people who want to help younger family members get on the property ladder themselves – or perhaps pay for university fees or other life costs.
Some people decide that travelling or holidaying is what they’d like to do with their retirement or older age.
An equity release lender won’t tell you what to do with your funds – so going on holiday or even buying a holiday property is perfectly possible.
A new car
Buying a new car is often a significant cost – and one that many older people cannot justify on their retirement income.
When you release equity from your home, the lump sum could buy a new vehicle outright – or provide a deposit for your next car.
How much does equity release cost?
There are a few different costs involved with equity release – some to be paid upfront and others charged as interest.
The upfront fees are similar to those required when you get a normal mortgage on a property – like arrangement fees, property survey and valuation costs, as well as the legal advice you’ll need from a conveyancing solicitor.
These costs are generally around £1,500 and £3,000 depending on the product you’ve chosen.
The amount of interest you’ll be charged by an equity release provider will vary from lender to lender – but it’s usually between 3% to 5%.
This figure is often much higher that for 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.
In an example given by Martin Lewis’s MoneySavingExpert website, someone who borrows £20,000 aged 60 at 5.1% on a £120,000 home would see the amount owing double every 14 years. Therefore, if that person lived to be 74, they would owe £40,000 – or, if they live to be 88, that amount would become £80,000.
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What are the pros and cons of an equity release loan?
Like any financial product, there are advantages and disadvantages to lifetimes mortgages and other equity release plans.
You get to stay in your home
No matter how much money you borrow or how long you live, you’ll get to stay in your home.
There are no monthly payments needed
Although you can make repayments to increase any inheritance that may be left after you die, you’re not obliged to make any repayment at all.
You’ll never owe more than your home is worth
Lenders who abide by Equity Release Council rules make a ‘negative equity guarantee’ – meaning you’ll never owe more than your home is worth. Any excess will be written off at the end of the agreement.
You can access money when you need it
Equity release lets you access the money that’s tied up in your home – giving you cash to spend on the things that are important to you.
You may avoid inheritance tax
Equity release may make it possible to gift money to loved ones without the inheritance tax they would have to pay if money was distributed as part of your will and estate.
It’s important to get formal equity release advice about this before you make any decisions though – inheritance tax and estate planning are complex and will require professional help.
Your debt will increase as interest is added
Since lifetime mortgage and home reversion providers use compound interest, your debt could go up significantly the longer you live.
This won’t have a direct impact on you – as you don’t have to make repayments and your outstanding loan is protected by a guarantee that you won’t end up with negative equity.
However, if you’re hoping that the sale of your home will leave some proceeds for family, this could stop that from happening.
Your benefits could be affected
If you receive any means-tested benefits, the sudden additional money that you have access to could change your eligibility.
This doesn’t just apply to benefits that you receive now. If you may get benefits in the future – Universal Credit or pension credit for example – then you should look into this with an accredited equity release adviser before you make your mind up.
You might have to pay an early repayment charge or exit fees
It’s perfectly possible to settle both lifetime mortgages and home reversion plans – but it may be expensive to do so.
There are likely to be significant interest costs if you settle a lifetime mortgage. Likewise, if you want to buy back the share of your house that you have sold as part of a home reversion plan, you’ll do so at the current market value, not the reduced price you got for it.
You won’t be able to leave your home as inheritance
If you’d like your house to be passed down to the next generations when you pass away, this will no longer be possible when you use any type of equity release product.
This doesn’t mean you won’t be able to leave anything – it just means that the lender will take control of your home when you die or move into longterm care.
Any funds left over when the lifetime mortgage is paid off will become part of your estate though – so there’s still every possibility that you can leave money as inheritance.
If you have a specific amount in mind that you’d like to leave, it’s a good idea to talk to an independent financial adviser and take a look at an equity release calculator to work out how much you’re likely to be able to leave.
There are set up fees
Like a standard mortgage, there are set up fees that must be paid upfront when you use equity release financial products.
As we mentioned earlier, these are likely to run between £1,500 and £3,000 and include legal fees, survey and valuation costs, along with admin and paperwork fees.
You won’t be able to take any further loans against your property
Some financial products allow you to use your home as security – but this will not be possible if you have any kind of lifetime mortgage secured against it.
Does equity release affect your tax or state benefits?
The idea of having any large amount of money coming into your bank account is likely to inspire questions about tax and benefits.
In terms of tax, there’s nothing to worry about. Equity release is exempt from Income Tax as it simply is not a source of income – it’s a loan that is eventually repaid.
Benefits are a slightly different matter though.
If you’re entitled to pension credit, Universal Credit, or other similar means-tested benefits, you may find that having additional money in the bank changes the amount you are entitled to.
If you’re thinking about an equity release scheme but receive benefits (or think you might in the future), you should seek financial advice from an equity release advisor. They’ll be able to look at how equity release might impact what you get.
Why has equity release had a bad reputation?
If you’re at an age when you’re considering equity release now, you might remember equity release products have a bad reputation in the 1980s and 1990s.
Back then, the most popular equity release products were ‘home revisionary loans’ – and these weren’t regulated by financial services industry bodies to protect the people who used them. This meant that there were no safeguards that the Equity Release Council and the Financial Conduct Authority (FCA) provide today.
One of the biggest criticisms of these products was the fact that ownership of the home was immediately signed over to the lender. This meant that when property prices went up significantly, lenders made a lot more money than people thought was fair.
There were also instances where people found themselves in ‘negative equity’ – owing more than the home was worth. This meant that debt could be left to the estate and would need to be paid off after the person passed away. In some other cases, lenders even took possession of the home before the person has died.
How does equity release work today?
Today though, this has changed significantly.
All lenders who are regulated by the Equity Release Council offer a ‘negative equity guarantee’ – a legal agreement that any debt will be written off after they take possession of the home.
What’s more, the way new equity release products are set up means there are no circumstances where anyone could get kicked out of their home.
What are some alternatives to equity release?
If you’re looking to free up some money in older age, equity release is just one of the options available.
Take a look at some of the other options people consider:
You may find that downsizing your home is a preferable option to equity release.
It doesn’t work for everyone – but for some people, it’ll free up enough cash to put a large sum into your savings.
Downsizing may also give you lifestyle changes that are helpful in older age.
Re-mortgaging your property can be done to release equity without eventually having your property go to the lender.
Not only are there new deals that could save you money, you may also find that the value of your home has gone up – meaning you have more equity in your property than you did when you last had a mortgage.
Talk to a qualified equity release adviser or independent financial adviser
When it comes to your money, it’s absolutely essential that you go into any legal agreement with all the information.
This is where an independent financial adviser and independent legal advice is important. In fact, it’s so important that any equity release provider or equity release broker you talk to will now insist that you get this advice before you progress with your plans.
Where can I get more advice on How Does Equity Release Work? and other debt solutions?