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What is equity release and how does it work?

  1. 31 December 2018
  2. By Andi Forsythe

Equity release is the ability to free up the equity from your property, whilst you continue to live in it. For many people, their property is their biggest asset, but all their savings are tied up in it.

Equity release allows you to withdraw either a lump sum or a monthly amount from the value of your property, in a similar way to a mortgage.

How does equity release work?

Equity release is a type of lending. You are accepted by a lender who will give you either the lump sum or regular amounts against the value of your home. When you sell your home, pass away or enter a care facility, the lender will claim the amount they lent you from the property. In terms of interest, it is added to the amount taken from the property when it is sold, or in some cases, you can pay it monthly.

Lifetime Mortgages vs Home Reversion

There are two main types of equity release.

1) The first is a Lifetime Mortgage. 

A lifetime mortgage is the most popular type of equity release scheme. You borrow against your property, and this is paid back when you pass away or move into long-term care. The interest ‘rolls up’ so there are no repayments, which can add up quickly. Some providers will let you pay the interest monthly which will cut down on the amount owed when the house is sold.

2) The second option is a Home Reversion.

A Home Reversion is where you sell either the whole or part of your property to a lender. You will get between 20%-60% of the value of your home (or if you sell a portion of it) and then are allowed to remain in the property for the rest of your life, or until moving into long-term care. You can receive the money as a lump sum or a regular income. There is no interest because you are essentially selling your property at a lower rate.

What are the main differences between a lifetime mortgage and a home reversion?

In a home reversion, you have effectively sold your property, but are allowed to live there rent-free. That means that you won’t benefit from any increase in the value of your property over time (or only on the portion you haven’t sold). With a lifetime mortgage, you still own your home, so if the value increases, that will still benefit you or your estate and can be used to pay off the mortgage.

There is no interest in a Home Reversion because you have received less than market value for the property, with the lender assuming it will be worth more when they take possession of it. With a lifetime mortgage, the interest ‘rolls up’ to the total payable amount, which can add up over the years, or in some cases, you can pay off the interest monthly.

Key points to consider for both Lifetime Mortgages and Home Reversions:

  • How old do you need to be to apply?
  • How much can you borrow? You will normally get around 60% for a lifetime mortgage or 20-60% of the value of your property for a home reversion, but this depends on the value of your home, as well as your age and health. Those who are older or have certain medical conditions may be able to borrow a larger amount.
  • Interest rates need to be fixed, or if they are variable, there needs to be an upper limit on how much the repayment can grow.
  • Check that you can continue to live in the property for life, or until you move into long-term care, as long as it is your main residence.
  • Ask about what happens if you decide to move home. Can you buy or sell, how might the equity release affect this?
  • Check if there is a ‘no negative equity’ guarantee, meaning that if your debt increases beyond the value of your property, your estate will not need to pay anything.
  • See if you can choose to take out a lump sum, smaller sums as and when you need them, or a mixture of the two. When taking out smaller amounts, you’ll accrue less interest, just be sure to check if there’s a minimum amount needed to pay.
  • Can you ‘ringfence’ a portion of your property for family members to inherit? This amount would be protected from either your home reversion sale or your lifetime mortgage amount.

Who qualifies for equity release?

You usually have to be over 55, (and usually older for home reversion) and there may be limits on what portion of your home you can borrow against. Bear in mind that the younger you are when you start borrowing, the more debt and interest you could accrue. Your property needs to be your main residence, and you will have had to pay off your mortgage. However, in some cases, you could use an equity release to pay off the remainder of your mortgage.

What are the risks?

In theory, if you start drawing down money quite early, or take a large sum, over the years it would be easy to accrue a large amount of interest. If the amount of equity you released plus the interest is worth more than your property upon your death, your family will be left with a hefty chunk of debt to pay. Some equity release schemes have a ‘no negative equity’ clause where it will cap the amount of the total value of the property. There are also some, where you can ringfence a certain portion of the value of your property for your children to inherit.

There have also been some cases where equity release was started too early, and older couples wanted to move home. Ensuring there was enough equity left in their home to buy a new property was harder after using equity release, leaving them stuck in that property when family or friends were elsewhere.

What are the advantages?

You’ll have more money for your retirement and to enjoy your life in old age. Your home is your biggest asset and you may want a little extra money to supplement your pension or to make life easier. Some use the money for travel and enjoyment, others use it to give children or grandchildren a deposit for their own property.

It also allows you to enjoy the money you put into your home without having to downsize or go into rented accommodation. You can continue living in your home whilst accessing the money.

Is equity release right for me?

Whether equity release is the right choice for you will depend on a lot of factors, including how old you are. Whilst it may sound unpleasant, the older you are, and if you have any illnesses, the more likely you are to qualify for a more generous equity release offer. Whilst equity release is accessible from some providers from the age of 55, the likelihood is you will live a lot longer, your interest will accrue, and you may end up costing the lenders more than they would make (especially if there is a no negative equity clause).

Older people who are certain they plan to stay in their property indefinitely fare better with equity release, as sometimes selling the property can be difficult when you have taken equity out. If you are capable of being on top of your finances and can keep an eye on the interest, especially for those who just take out ‘roll down’ cash amounts as and when they need it, so you’re not paying for money you are not using, equity release could give you a new lease on life. Whether that’s making life a little more comfortable, or accessing cash to treat the grandchildren at the weekend, in the right circumstances equity release can be a great tool.

Similarly, if you don’t have children or family members you are leaving the property to, you could benefit from enjoying the money locked up in your property and then the lender simply taking hold of the property later on.

What other options are there?

In some cases, it depends on what you want the money for, as equity release may not be the right option. If you want a one-off sum, a personal loan may be an easier option. If you are looking to make changes to your property to make later life or living with a disability easier, there may be grants available. If you are simply looking to free up some money from your property, downsizing may be a good option, though take into account the costs associated with moving, including conveyancing, surveying, removals and stamp duty.

What are the costs?

There are four possible costs when it comes to applying for equity release:

  • A solicitor
  • An equity release advisor/financial advisor
  • Lender’s application fee
  • Valuation

If you are interested in equity release and setting it up, talking to an expert equity release advisor who is familiar with equity release schemes will set you on a path to the right scheme for you. When you are ready to go through with the process, a conveyancing solicitor who has experience of equity release will be able to get the ball rolling. Home reversions can take a little longer than lifetime mortgages to be finalised, but usually, the process can take about 6-8 weeks.

Will it affect my benefits/pension/income tax?

If you are on means-tested benefits, some of these may be affected by drawing down money from an equity release. Things like reduced council tax, income support or other benefits may be reduced so it is worth talking to your equity release advisor, as well as the local authority or benefits office to make a choice that works out best for you.

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