How Does Equity Release Work?

April 2020
How does equity release work

If you’re over 55 and want access to the cash tied up in your home without moving then consider an equity release mortgage. But How Does Equity Release Work?

 

 

What is equity release?

As a homeowner, each month you pay off a tiny fraction of your mortgage (unless you took out an interest-only mortgage). While the percentage is tiny, your equity continues to build. As long as you keep paying, years down the road you’ll own the house outright.

 

A problem that arises with having a large percentage of your net worth tied up in a property is that your goals shift as you get older. You might want to use some of that cash for a once in a lifetime holiday, to help your kids get on the property ladder or another worthwhile reason.

 

While you could sell your home and downsize, releasing some cash in the process, this isn’t an option for everyone. For example, your local area could lack suitable, smaller properties or you could face a large capital gains tax bill if you sold. You might still love where you live and can’t face moving.

 

An equity release allows you to stay in your current home yet allows you access to some of the cash you’ve built up. There are two equity release options: Lifetime mortgage and Home reversion.

 

 

Lifetime mortgage

A lifetime mortgage product allows you to remortgage your main residence while retaining ownership and is available if you’re aged 55 and over. You can ring-fence a percentage of the property’s equity for inheritance as the maximum loan amount is 60% of your property’s value.

 

You have the option to make repayments or can let the interest roll-up (meaning its added on the final repayment amount). When you die or move into long-term care, the loan and any accrued interest will need to be repaid in full.

 

As with other mortgage products, there are several lenders to choose from, each offering slightly different products and terms. A mortgage broker can help you navigate the market and find the right product for your situation and goals.

 

Pros

  • You can keep living in your home rent-free for life or until you need to move into long-term care.
  • Your interest rates will either be fixed or capped if they are variable for the life of the loan.
  • Products offer a “no negative equity guarantee”. When your property is sold, if you can’t repay the full loan from the remaining equity, neither you or your estate are liable for this difference.
  • You can still move home. However, your product provider will have to agree to accept the new property as security for your equity release loan.
  • You might be able to withdraw small amounts rather than taking a lump sum, which will reduce the amount of interest owed.

 

Cons

  • As we’re living longer, costs can quickly spiral, particularly as the interest rate will be higher and there’s no fixed loan term.
  • You could end up stuck in your property unable to move as your provider doesn’t agree on a potential property.
  • If you want to pay off the loan, the early redemption costs can be high.
  • You’re still responsible for maintenance and running costs.

 

 

 

 

Home reversion

Another option you have is home reversion. As long as your 65 or older, you can sell part or all of your home to a home reversion company. In return, you either get a lump sum or regular payments. You can continue to live in the property rent-free until you die. However, you’re still responsible for maintenance and insurance.

 

Like with our first option, you can ring-fence a percentage of your property for inheritance. At the end of the plan, your property is sold and the sale proceeds are shared according to the remaining proportions of ownership.

 

Pros

  • You can keep living in your home rent-free for life or until you need to move into long-term care.
  • There’s no interest to pay as you’re not taking out a loan.
  • You can decide the size of the percentage you sell
  • As you choose to sell part of your property, when you die, you’ll still be able to leave an inheritance.

 

Cons

  • You will have to sell at a discounted price
  • While you’re able to live in the property rent-free, you no longer own it.
  • You’re still responsible for maintenance and running costs.
  • Depending on what percentage your sell, you won’t fully benefit from any house price rises.
  • Your options may be limited and you might not be able to easily move.

 

 

What are the risks involved with an equity release?

If you need extra cash and don’t want to move, an equity release might seem like your best option. However, there are risks and downsides.

 

With both options, you’ll still be required to pay fees which can range from £1,500 to £3,000 and cover the legals, valuation and arrangement fees.

 

You might find it harder to borrow money as you have fewer assets to use as security. You won’t be able to rely on your property for cash if you require some late in your retirement. This could mean you struggle to pay for long-term care.

 

The money you receive from equity release might affect your entitlement to state benefits and other government support.

 

If you change your mind, it could be nearly impossible to unravel the scheme and reclaim your entire property.

 

You might feel unsettled knowing that you no longer completely own your home or find it difficult to move, adding pressure to what is already a challenging prospect.

 

 

 

 

Should I consider releasing equity?

The answer depends on your circumstances such as your age and income as well as your goals. It’s very easy to focus on the immediate boost your cash influx will have but you should also consider your future and financial situation as you age.

 

You should also consider if you can remortgage as you’ll still own the property and be in control. You might be able to make regular cash by renting out a room that could have the same effect as releasing equity.

 

 

Seek advice from an independent financial adviser

As all independent financial advisers (IFAs) must have a specialist qualification to recommend equity release schemes, it’s worth talking with one. Use the Equity Release Council members directory to find your nearest qualified advisor.

 

They will be able to advise you if equity release is the right choice for you and be able to suggest the right product for your circumstances and goals.

 

It’s worth speaking with a whole of market IFA as they’ll have access to the widest possible amount of options. They’ll also be able to advise you on other fees you’ll need to pay such as legal fees, set-up costs and valuations.

 

Most IFAs will charge for their service, however, it’s money well spent.

 

 

So, how does equity release work?

Before releasing equity in your home, consider your options. You might be able to release cash by downsizing or by renting a room out.

 

Also consider the overall cost. You might be able to release £25,000 today but it could end up costing you £75,000. So ask for advice from a IFA and do your own calculation.