By Tom Philips at January 2, 2023

Equity Release Pitfalls You Should Avoid

Before we get into equity release pitfalls you should avoid, we want to outline the pros of the equity release scheme.

Firstly, equity release provides homeowners with the opportunity to access money when they may be currently cash poor. They can use this money for anything they want, from home improvements to family holidays.

As the money does not have to be repaid, and it is free of tax, homeowners can access more funds than they would be able to with a traditional loan scheme. This allows them to enjoy their retirement exactly how they’d like to.

Secondly, anyone who is over the age of 55 and owns their own home can take out equity. This scheme does not discriminate against people with a bad credit rating or a low income, which means it’s an easy way for pensioners to get out of a financial rut and have a fresh start.

Finally, equity release does not cost a lot of money. Though there are fees involved with the scheme, they are almost always below £3000, and this is definitely worth it when you consider how much money you would be releasing from your home afterwards.

The Pitfalls Of Equity Release

As much as equity release can solve many people’s financial issues, it comes with some serious pitfalls. We will introduce you to 13 of these so that you can be aware of what you need to look out for when you are finding the right equity release lender and plan.

Pitfall 1: Compound Interest

The first pitfall we want to talk about is compound interest. When you borrow money from an equity release lender, you will not only owe the amount of money you borrowed.

You will also pay interest on the loan amount every year, so the interest will accumulate for the duration of the scheme. This is called compound interest.

If your interest rate is high, this is something to be very careful about, but even low interest rates can lead to high levels of debt when the interest racks up each year.

In terms of avoiding this pitfall, all you can do is make repayments on the interest through an interest only lifetime mortgage. This would involve paying back the interest each month, which would prevent it from accumulating.

If you do not have the means to do this, don’t worry too much about the growing interest, as it does not have to be repaid while you are alive. Though it is a type of debt, it is not like traditional debt in the sense that it would be very detrimental if you could not afford to repay it.

Something else you could do is select a plan with a low interest rate that is fixed, so you know how much interest you would end up owing. If you are determined to go for a variable interest rate, make sure it is capped at a certain percentage, and speak to a financial adviser about whether this is likely to be profitable for you.

Pitfall 2: Inheritance

It is well known that releasing equity tends to have a negative impact on the amount of cash you can leave to your loved ones when you die. This is certainly something to look out for, as you could end up with no inheritance for your family with equity release.

The reason equity release reduces inheritance funds is that you are taking equity out of your house, meaning it decreases in value. What’s more, as you don’t make repayments on the loan, the equity release lender gets their money back by selling your house after you have passed away. This means your family would not inherit your home.

Though you cannot avoid this, as it is the only way equity release works, you can ensure your family is left with some money. You would do this by selecting an equity release plan with inheritance protection, which is provided by many equity release lenders.

Something else you could do is gift money to your loved ones while you are still alive, as the money would be tax-free if you offered it at least seven years before you died.

You could give money directly to a family member, or you could offer to pay for something like a holiday, a mortgage deposit, or a wedding.

Pitfall 3: Negative Equity

We have mentioned how compound interest can negatively affect your finances, but we have not explained how this would play out at the end of the equity release scheme.

Sometimes, if your home has decreased in value since you took out equity, or if your interest has racked up significantly, you will end up owing the lender more money than you borrowed from them. This is known as negative equity.

It goes without saying that this is not an ideal situation, as your family would have to repay the debt for you. They may be able to use some of your other funds, but if not, they would be expected to use their own money to pay the lender.

Fortunately, most equity release lenders now offer a no-negative equity guarantee, which promises that you will never have to pay back more money than you borrowed (1). Families of equity release consumers can now relax in the knowledge that they will never have to cover the debts of equity release.

Pitfall 4: Set-up Costs

Sometimes, people are so focused on the equity loan that they neglect to consider how much it costs to take out equity. There are fees that are charged throughout the application process, from when you first seek advice to when your solicitor accepts the offer on your behalf.

As we mentioned previously, these fees usually do not exceed £3000. However, this is still a lot of money for some people, especially if they are no longer working. You need to ensure you can afford this before you take out equity.

However, it is sometimes possible for you to delay the payment until you receive your loan, so you can use the loan to pay the fees. What’s more, you can attempt to keep equity release as affordable as possible by finding free or budget-friendly advice and selecting an affordable equity release provider.

Pitfall 5: Early Repayment Fees

Another pitfall of equity release is the fact that once you have received your equity loan, you are expected to be committed for life. This includes sticking with your equity release lender and plan, and staying in your property for the rest of your life.

Most lenders will allow you to finish with equity release early, but there may be charges involved with doing this. You will sometimes be charged an early repayment fee, that can be up to 25% of your initial loan amount.

Early repayment is sometimes calculated on a sliding scale, so the longer you have been an equity release consumer, the cheaper it will be to repay the loan early and exit the scheme.

To avoid early repayment fees, you could find a lender who does not impose them. If not, make sure you are very confident about your decision to take out equity, as this will reduce the chances that you will regret borrowing money.

Pitfall 6: Entitlement

The sixth pitfall is the fact that you may not be eligible for equity release, and you could end up having an application rejected if you do not confirm your eligibility with an adviser first.

Only homeowners can release equity, and they must also have a property worth £70,000 or more and be 55 years old or more to qualify. There are various other conditions that may apply for certain equity release lenders and plans.

There are some criteria that you cannot fit no matter how much you try. For instance, if your home is worth £60,000, you will not be able to take out equity. However, this is very uncommon amongst pensioners as many of them purchased their home years ago and have watched it increase in value significantly over time.

However, in terms of age, if you are 53 years old, you could get the ball rolling with equity release by seeking advice and researching the scheme, ready to make an application when you turn 55.

Pitfall 7: Moving Home

If you are not completely content with your current property, or you are not comfortable with the prospect of staying there for the rest of your life, keep in mind that it can be difficult to move home after releasing equity.

Some equity release lenders will not allow you to move home at all, and others will impose restrictions on this. This is particularly something to consider if you live far away from your family and you may want to move closer as you get older, or if you have always dreamed of living in a certain location.

Something you could do is move into your preferred property and release equity from this property, as you would be more likely to want to stay there forever. You could also find an equity release lender that is an Equity Release Council (ERC) member, as they have to allow you to move house (2).

However, they do not have to allow you to live in any property. They will only approve of certain properties, and they are allowed to have conditions such as the property being in a certain location or being a certain size.

They may request that the property is a particular value. If the value is lower than your current home, you will most likely have to repay some of your loan when you move house. If the value is higher, you may be entitled to a higher loan amount.

Pitfall 8: Younger Homeowners

Not everyone gets the same benefits out of equity release, and younger homeowners tend to be the worst off. This is something to seriously consider if you want to release equity and you are only 55 years old.

Generally, older homeowners will be entitled to borrow more money and pay less interest. This is because they tend to be on the scheme for a shorter period of time, so the equity release provider gets their money back much sooner.

There is nothing you can do about being a younger homeowner, so all we can suggest is finding an equity release lender with great benefits, and an equity release plan with low interest rates.

You may decide to simply wait a few years before you release equity in order to access more of the benefits. We only recommend this to people who are financially comfortable, such as people who are still working, have a pension, or have sufficient savings.

If your partner is older than you, they could file an individual application for equity release and add your name to it when you turn 55 years old. This would be ideal in terms of accessing low interest rates and high loan amounts.

However, in the event that your partner passes away before you turn 55, you would be expected to vacate the home and you would not inherit the equity release funds. For this reason, it is not advisable to make a single application if you are in a large age gap relationship, or if your partner is in very poor health.

Pitfall 9: Borrowing Limits

We often talk about how much money you can release with equity, so you may automatically assume you would be eligible to release a life-changing amount. However, this is not always the case.

Each homeowner can release 20–60% of their property’s value with an equity release lifetime mortgage, and the higher rates tend to go to older homeowners with highly valuable homes.

If your home is not much more valuable than £70,000 and you are only 55 years old, you will not be able to release as much as a 90-year-old with a £500,000 property.

If you have a home reversion, you can release 25–100% of your property as you sell it to an equity release lender. Though this may grant you more money than a lifetime mortgage, you will still often receive less than the market value of your property from the lender.

There is nothing you can do about how much money you can release, apart from waiting a while before getting involved with equity release. However, you could do research into what the amount may be, and decide whether it would be worth it in relation to what your current financial situation looks like.

Try out our free equity release calculator. All you need to do is tell us your property type, property value, and age, and the calculator will do the work for you. We also offer personalised quotes to help you discover how much money you could release from your property.

Pitfall 10: Borrowing Too Much Money

It is also possible that you will be drawn in by the amount of money you could borrow through equity release, and that you will borrow the maximum amount without considering the impact of doing this.

The more money you borrow, the more you will owe. If you do not have to do this, as you can rely on employment income, savings, or a pension, it would be better to borrow a smaller amount and be in less debt.

However, if you are struggling to cope with the rising cost of living and you are worried about how you are going to afford to retire, borrowing the maximum amount would be a no-brainer. It’s a case of assessing your personal circumstances.

As we have explained, you do not have to pay back the loan amount, so borrowing the maximum amount would only affect your family. It’s up to you to decide whether you would rather have this money now in retirement, or save it for your loved ones when you pass away.

Pitfall 11: Benefits Entitlement

If you claim means-tested state benefits, it is possible that releasing equity will remove your entitlement, and you will no longer receive benefits payments in the future (3).

Some people have been caught out by this as they have not done enough research into equity release before requesting a loan.

This will only happen if you release a lump sum and it goes over the benefits entitlement threshold. If you keep most of the money in your bank to withdraw when you need it, it is not classed as income, so you would most likely keep your benefits.

There are also certain benefits that will never be affected by equity release. One of these is disability benefits, and the other is the personal independence payment (PIP). Both of these are paid regardless of the income of the recipient, so it doesn’t matter whether or not they have an equity loan.

The best thing to do if you are claiming benefits is to speak to a financial adviser about how equity release could affect your benefits. Make sure the adviser is trained in equity release so that they understand the nuances of the scheme.

Pitfall 12: Advice

Some homeowners decide to take out equity without seeking advice. It is obligatory for them to have at least one face-to-face meeting with a solicitor, but they may not arrange anything beyond this.

The reason not seeking advice is a pitfall is that you may end up being scammed by an equity release lender. A less extreme possibility is that you will be misinformed about equity release.

You may feel as though you are as informed as possible because you have done independent research into equity release. This certainly puts you in a better position than someone who has not looked into the scheme much, but professional advice is still the way to go.

By seeing a wide range of professionals, you will get many different tips relating to equity release, and you can choose for yourself which ones you take on board. We recommend finding a financial adviser, an equity release adviser, and a solicitor who is an equity release specialist.

Pitfall 13: Your Property Value May Increase

Something many people overlook when it comes to equity release is the fact that your property value may increase after you receive your loan, and in certain situations, you would not benefit from this increase in any way.

If you have taken out a lifetime mortgage, this is not an issue as the lender would get more money from your property sale, reducing the likelihood that you would be in negative equity.

However, if you have had a home reversion, you have already sold your home to an equity release provider, so only the provider will benefit from an increase in the property’s value.

This is something to consider if you believe your property is likely to increase in value in the future, as it would be a shame for you to see this money go to someone else, when you could’ve waited and sold your home for more money.

How Can I Avoid These Equity Release Pitfalls?

Fortunately, there are things you can do to avoid these common equity release pitfalls.

Firstly, as we have suggested, find a good team of advisers who are knowledgeable about equity release. Make sure they are willing to be honest about the potential downfalls of the scheme, and the pitfalls we have discussed.

You may be tempted to not use a solicitor except for a one-off appointment, but we believe this can make the difference between an unsafe equity release scheme and a safe one. Solicitors will take charge of the equity release process to take the pressure off you, and they will advise you on any potential legal issues.

Secondly, please make sure you do enough research into equity release before committing to it. This will ensure you are aware of all of the potential pitfalls, and that you are prepared to handle them in a sensible way.

We advise using our website as a reliable source of information for equity release. Our FAQs page is a favourite for our equity release customers, but you would also benefit from our blog that covers various aspects of equity release, some of which will apply to you.

Finally, speaking to your family may help you to avoid some pitfalls. This is especially true if you have any family members who have released equity themselves, or who have experience with funding their retirement.

Sometimes, learning about the many different aspects of equity release can get overwhelming, and you need a family member to help you digest the information properly.

They can also help you to get your finances in order to figure out how much money you would have for retirement, whether it is in the form of a pension, savings, benefits, government grants, or employment income.

Why Should I Release Equity If There are So Many Pitfalls?

You may be wondering why you should bother taking out equity if there are so many pitfalls to avoid. Here are some reasons to not let equity release pitfalls deter you from taking part in the scheme.

1. Not all of the pitfalls will apply to you

We have listed the many potential equity release pitfalls you should avoid, but not all of these will apply to you. For example, we have mentioned not being able to move home with equity release, but this would not apply to people who choose an equity release plan that includes downsizing protection.

Another example is benefits entitlement. Many of our customers are not currently claiming state benefits, so there is no need for them to consider how equity release will affect their entitlement to benefits.

As well as some pitfalls simply not applying to you, you can take steps to ensure certain pitfalls don’t affect you, such as finding an equity release lender that meets your needs and seeking plenty of advice.

2. You may be in a desperate situation

If you are financially comfortable and you would like to take out equity, that’s one thing, but if you are in desperate need of boosting your finances, it may be worth risking the equity release pitfalls in order to access an equity loan.

When you are worried about entering later life poverty, suddenly compound interest doesn’t seem like a big issue. Similarly, if you have many outstanding debts, taking out a mortgage that does not have to be repaid, and can be used to pay off your debts, no longer seems as risky.

3. There is no other scheme like it

You can search far and wide for a scheme like equity release, but you will not find one. No other scheme allows you to borrow money that is secured against your own property, and you will not be able to skip repayments with any other loan.

What’s more, you would struggle to find another scheme that is so accepting of people with a tricky financial history. Equity release is truly a fresh start, as you can borrow money regardless of your income and credit score.

Finding an Adviser

Booking a consultation with an Equity Release Warehouse adviser is a great way to find out more about which equity release pitfalls you should avoid. We will make the potential effects of equity release very clear, whether they are positive or negative.

In order to do this, we will need to ask you personal questions about your finances. We will not judge your responses, as we are simply aiming to understand more about your situation so that we can recommend the best equity release plan to you.

If we do not believe that equity release would successfully fund your retirement without having too many negative consequences, we will inform you of this. There are other alternatives to consider, including borrowing from loved ones, traditional loans, downsizing, and remortgaging.

Remember that it is possible to avoid some of the downsides of equity release, and our advisers can help you with that if you tell us what you are concerned about.

For example, if you do not want to face an early repayment charge, we will help you to find a lender that does not implement this. If you are after low interest rates, we will introduce you to schemes that offer this.

Something else to consider is the fact that there are many different types of lifetime mortgage to choose from. One of these is the enhanced lifetime mortgage, which is available to people in their later life, as well as people with particular disabilities including high blood pressure, cancer, and heart problems.

If we believe you are eligible for this, we will most likely recommend this arrangement, as it tends to provide homeowners with low interest rates and high loan amounts.

It may also be possible to release additional money for specific purposes, such as home improvements to make your home better equipped for your disability or age.

Once we have deemed you potentially eligible, we can help you apply to an equity release lender who will most likely request proof of disability, such as medical notes.

This can lengthen the equity release application process, making it slightly longer than the standard 7 weeks. However, it would be worth it in the end as you would have more benefits than the average equity release consumer.

To find out how to apply to an enhanced lifetime mortgage or any other equity release scheme, get in touch with us on 0330 058 1579 or request a callback. Our initial consultations will not cost you anything, so there is nothing to lose in speaking to an adviser and finding out which equity release pitfalls you should avoid.

There are a wide range of equity release companies out there, but few will offer you the level of attention that we do at zero cost.

Our consultations are extremely personalised; you will never receive vague advice on equity release, but instead, we tailor our suggestions to your personal situation. This is something we are very proud of, and it explains why our customers come back to us for advice time and time again.

References

[1] What is a no negative equity guarantee? https://www.equityreleasecouncil.com/what-is-equity-release/faq/what-is-a-no-negative-equity-guarantee/#:~:text=Products%20which%20fully%20meet%20the,worth%20when%20it%20is%20sold.

[2] Can you move home if you have equity release? https://www.thetimes.co.uk/money-mentor/article/equity-release/

[3] How does equity release affect state benefits? https://moneyfacts.co.uk/retirement/guides/how-does-equity-release-affect-state-benefits/