What is equity release – a general guide
I recently saw a client, close to retirement who asked about Equity release from his property and was it of any use to him? I confess that I was unable to give an instant answer as I possessed only sketchy knowledge myself, so I approached one of the members of the WEA Panel of Professional Advisors and they provided a relatively simple guide to the advantages and disadvantages of undertaking such a financial transaction.
What is Equity Release? It is also known as a lifetime mortgage – allows you to release a tax free lump sum from the equity in your home and you are free to use the money however you choose. What’s more, you can stay in your home for life, with no mortgage payments required as the interest is usually added back to the mortgage.
How does Equity Release work? Lifetime mortgages are generally only available for people aged 55 or over, the loan is secured on the property of the borrower and the borrower retains ownership of their property. The loan is typically repaid upon the death of the borrower or another trigger event, such as the borrower moving into permanent nursing care. The monies advanced are usually repaid from the proceeds of the sale of the property and, more often than not, the Lifetime mortgage will carry a “no negative equity” guarantee.
There are three main types of equity release: a lifetime mortgage, a draw-down, or flexible, lifetime mortgage and a home reversion scheme.
The most popular type of scheme by far is a draw-down mortgage since it allows the release of cash over time, as and when it’s needed. Typically, this sees the homeowner borrow a lump sum that they can take from their property in manageable tranches. The interest then builds up at a fixed rate on each part of the mortgage as it is drawn down, and is repaid from the proceeds of the sale of the property when the person – or both residents, if a couple – has died or goes into care. As interest is only payable on the amount drawn down, these plans can often prove the most cost-effective.
Similar to this is a standard lump-sum lifetime mortgage; with this, you get all the borrowing at once. As interest accrues from the moment you take the loan, though, it can typically double every 11 years. This is more expensive than a draw-down mortgage.
Finally, a home reversion plan is where you sell all or part of your home in exchange for a cash sum to fund your retirement. You can stay in your home for the rest of your life, but you would be selling your home at a discount, that is far less than its actual worth. Unlike lifetime mortgages, a home reversion plan is not a loan, so you have no interest or repayments. Instead, the equity release Company benefits from their share of your property when your home is sold after your death on the basis that it will have increased in value.
What can equity release be used for?
It can fund retirement - this by far the most common reason for an equity release plan. Approximately half of those who tap into the wealth in their home do so to help themselves in retirement. This includes making up shortfalls left by small pension pots, paying for home improvements or even funding such things as one-off holidays-of-a-lifetime.
It can pay off debt - roughly 35% of people who release equity from their homes are doing so to pay off debts, according to figures from one equity release provider, Just Retirement. Many people can afford to make only the minimum repayments on their debts meaning they will be paying a lot of interest for a long time. Borrowing from your home could, in some circumstances, be a cheaper alternative to racking up debts and paying interest on a credit card.
You can support your children – this area of the equity release market is starting to grow as an increasing number of home-owning families consider unlocking their wealth. With the younger generation struggling to get on to the property ladder, to obtain credit and to pay off student loans, more and more are falling back on their parents’ generosity.
What are the disadvantages?
Whilst early access to personal wealth tied up in capital can seem an attractive option there are down sides too:
• You no longer have control of the ownership of your home – your freedom to sell and move is severely curtailed – you have effectively sold part or all of your house whilst still living in it.
• Interest charges can mount up. The longer you borrow money through an equity release plan, the longer interest charges have to build up. In some cases, this can mean that at the end of the plan, you or your family could end up owing the whole value of your home to the equity release company.
• Your family could get a smaller inheritance. If you sign up for equity release, it is inevitable that at least some of the value of your home will have to go to repay the provider when you die or move into care.
• You could miss out on house-price rises. If you use a home reversion equity release plan, you effectively sell some or all of your home to the provider. This means you and your family will not benefit from future house-price rises on the portion you have sold.
• It may still count towards local authority assessment of personal wealth when means testing for local care support.
The above is a very simple guide to the headlines of equity release. There is a great deal to consider before committing to a lifetime mortgage, so please ensure that you take advice from an expert in this area before entering into any financial commitment. Equally since equity release has a big impact on an inheritance, it is good practice to include children in discussions when first considering it.