You may have seen adverts on TV mentioning Equity Release and how, for the over 55s mainly, it can be a great way to a more comfortable life in retirement. Rates are at the lowest they have been in recent years, but does that mean Equity Release is always a good thing? Let us explore exactly what Equity Release is and how it works.
What is equity release?
In a nutshell, equity release is a way of unlocking your property’s value, turning it into a lump sum to spend however you choose. There are a few different ways of accessing or releasing the cash (equity) that is tied up in your property if you are over 55 years of age. You do not need to have paid off a mortgage in full to be able to do this either.
Generally, the money released can be in a lump sum or released in smaller amounts over time (on which interest is paid), or a combination of the two.
Why do people want to release equity?
People choose to release equity in their property for several reasons. Often, they wish to carry out home improvements, repay other debts, or help their children get onto the property ladder. For some, it’s merely a case of enjoying life while they can without as many financial restrictions day today.
Should you release equity in your home?
This is a decision that only you can make. You should seek professional advice before you take the plunge. Releasing equity does have risks. So you should evaluate the possibility of downsizing before you jump right in.
This is a choice that many older people make as it also allows them to choose a home that may be more suitable for their needs as they age, such as a property with fewer stairs. If downsizing is a viable option, it is not one that should be put off for long. Many people have plans to downsize and then reach a point where they believe it is too late to make a move.
Downsizing is not for everyone. If you could not afford to stay in the same location, it can have an impact on your social and personal life, especially if you move somewhere new or away from friends and family. Often, people who decide to downsize find that they cannot afford to stay within the same location, despite downsizing. There are also additional factors to consider, such as fees for moving.
How could equity release work?
Instead of downsizing to release funds, equity release works as a plan to release tax-free cash. Let us take a typical example:
Mary and Joseph bought a home 30 years ago. They bought a house that was of the typical, average price back then costing £63,000. This house now has a value of £217,000. Their home is now mortgage-free as they worked hard to pay off the mortgage when younger. They can now release some of this as tax-free cash to spend as they wish. The amount that they can borrow against the home will depend on the property, where they live, and how old they are.
Types of equity release
Equity Release can be done in two ways: a lifetime mortgage and a home reversion plan.
A lifetime mortgage is a plan that most people aged 55+ typically choose. You borrow some of the value at a capped or fixed interest rate. This type of policy does not usually have monthly repayments. You repay the plan upon death or when moving into a care facility. However, unlike standard mortgages, the interest compounds quickly as the amount owed increases throughout the mortgage’s (and your) life.
There are drawdown versions of these mortgages which allow interest repayments and even some with capital repayments too so that the cost reduces overall.
Lifetime mortgages allow you to take money out of the equity a little at a time up until an agreed limit. The lender charges interest on the amount taken rather than the full total available.
The typical rate for a lifetime mortgage is around 5%. But there are some lower rates available. This is typically higher than standard mortgage rates. The price tag on the estate can and does become eye-watering if you don’t make any payments in reducing the debt as the interest continues to compound on an ever-increasing amount.
For example, Ingrid is 60 years old and borrows £20,000 with a 5.1% interest rate on her home that is worth £120,000. The amount she owes will double around every 14 or so years. If she lives until she is 88 years old, she will owe around £80,000, which is a staggering amount given the property’s worth.
She will also need to pay arrangement and set-up fees when taking out the equity release, which can be up to around £3,000 depending on the plan.
Home Reversion Plans
Home Reversion Plans are typically available for those that are over 65. With this type of equity release, a lender gives you a tax-free sum for a part of your property below its market value. You then live there until you die, rent-free. When the property eventually sells after your death, the proceeds from the sale are split depending on the different percentages owned by the lender and the property owner. With this type of equity release, the amount the provider gets will increase if there is a significant rise in the property’s value.
Here is an example:
Bernard and Gerard sold 40% of their property to a lender. Their property was worth £200,000 at the time, and they got a lump sum of £40,000. As you can see, this is half the actual market value of 40% of the property at the time. This is because the lender will need to wait a while to have the money returned. When Bernard and Gerrard both died, the home had increased in value and sold for a figure of £300,000. The lender can then claim their 40% share of the proceeds, which would mean that their entitlement is for £120,000, far greater than the initial £40,000 that they released initially.
Essentially, the difference in the two types of equity release is that home reversion plans are a better choice if the property price stays stable but are significantly worse if there is a substantial rise in value. With lifetime mortgages, you will always know the exact rate to be charged.
The Pros and Cons of Equity Release
There are many advantages to releasing equity (if there were not, nobody would do it!). One of the biggest reasons people opt for equity release is because it is so flexible. You can use the released money for anything you wish with no restrictions. You can also choose when and how much to release.
With equity release, you do not need to leave your home and downsize your property but still have the advantage of the cash. It saves on stress, moving costs whilst giving you more financial freedom.
Most equity release plans also come with a negative equity guarantee. This means that if your home’s value drops, your loved ones will not need to repay the difference to a lender once you die or move into a care facility.
The main disadvantage of releasing equity in your property is that it reduces the value of your estate. But you can minimise this by taking advantage of different plans that have various features.
With lifetime mortgages, the fact that interest continues to compound on an increasing amount means that it ‘rolls up’ and, when the plan ends, it is added to the final amount owed. The longer the plan continues, the higher the interest that will need repaying. There are ways to minimise this; however, so it is essential to seek financial advice when taking out any form of equity release.
Another drawback of equity release through a lifetime mortgage is that they are expected to last until the end of your life. As a result, there are high charges should you wish to repay the equity release before you die.
Many new plans come with a fixed term during which you would face charges, and after the term has ended, there are no hefty fees.
Equity release also reduces your estate value. This means that, when you die, the inheritance for loved ones will be smaller. That said, you can have an inheritance plan too, whereby a proportion of the property is safeguarded. It is crucial that you also think about any implications of inheritance tax when you consider taking out an Equity Release plan.
The type of Equity Release plan that is most suitable for you depends on your needs and personal circumstances. A lender will accept your application based only on the advice of a qualified adviser. Many lenders welcome discussions and would recommend that you also discuss your intentions with your family members due to the nature of equity release plans.
Our residential conveyancing solicitors can provide pragmatic and personal legal advice.
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