By Tom Philips at December 8, 2022

Equity Release Interest Rates

To help you better understand equity release interest rates, we are going to introduce you to a few terms that you will frequently read about when researching this topic.

1. Compound Interest

Compound interest, also known as roll-up interest, can be defined as ‘interest earned on interest’ (1). We will explain how this works with equity loans later on.

2. Loan-to-Value Ratio

This is not strictly related to interest, but recognising this phrase will help you to better understand equity release interest.

A loan-to-valueHome Reversion Plans ratio is a figure that demonstrates how much risk is involved with the lender offering a loan. Loan to value ratios for lifetime mortgages range from 20–60%, and for home reversions they can be anywhere from 80–100%.

If the lender is risking more by providing you with a loan, they are likely to offset this by offering a high interest rate, and vice versa.

3. AER

The AER is the Annual Equivalent Rate. This is the amount of interest that is added over the course of a year.

4. MER

The MER is the Monthly Equivalent Rate. It is still calculated based on the amount of interest added over the year, but this is then divided over each month.

5. Negative Equity

Again, this term is not strictly related to interest, but it is very much connected. When you end up owing more money than you borrowed, this is known as negative equity.

Often, this happens to equity release consumers as a result of not repaying the interest on their loan, as the interest then rolls up and causes them to owe a huge amount of money.

Do You Have to Pay Interest On Equity Release Funds?

Yes, you do have to pay interest on equity release funds. However, the exact interest rate will differ depending on which equity release lender you are with and which equity release plan you have selected.

There is no way to avoid paying interest on your equity loan, but there are certain things you can do to keep the interest as low as possible, and we will give you some tips for this if you keep reading.

Why Do You Have to Pay Interest On Equity Release?

Interest is a common feature on most loans, so the idea of paying interest should not be new to you. The general reason behind interest is that it benefits the loan lender, as they would otherwise be losing money by transferring funds to you without charging interest.

As for paying interest on equity release specifically, it is all the more important, as repayments are not a part of the scheme.

Homeowners are not obliged to pay back the money they borrowed while they are still alive, so by charging interest on the loan, the lender is able to loan money with the confidence that it will be worth it by the end.

What’s more, equity release schemes last much longer than the average loan scheme. This is because they tend to last for the duration of the homeowner’s life, or until they enter long-term care.

This means that the lender has to wait a longer period of time before they get their money, so charging interest is a sensible way of creating a fair balance for the consumer and lender.

Finally, one obvious reason for paying interest is that there has to be some sort of cost for borrowing such a large amount of money from a company.

Most equity release customers are cash poor and would struggle to fund their retirement without an equity loan, so it makes sense that they should pay interest on the money that is helping them to avoid later life poverty.

What Type Of Interest Does Equity Release Use?

Equity release relies on compound interest. We will give a general example to help you understand how compound interest works.

If you earn interest on a savings account, compound interest would mean interest would be added to the established interest amount on a regular basis, and this would cause the interest to grow quickly.

Compound interest on equity release means you will not only be charged basic interest on your loan amount, but you will also be charged interest on your interest amount that remains at the end of each year.

It goes without saying that the yearly interest amounts will differ for each equity release consumer as it depends on the amount of money they borrowed and whether they are making any repayments on the interest (just because it is not mandatory doesn’t mean it cannot be done).

Fixed Interest Vs Variable Interest

There are two types of interest rates: fixed interest rates and variable interest rates.

If your equity release lender charges a fixed interest rate, this means you are given a percentage of interest that you will be charged, and this percentage will not ever change.

For example, if your lender charges 3% interest on your loan, each year, you will be charged 3%.

On the other hand, variable interest rates can change when the situation changes, such as when your plan becomes more or less popular, or when your lender experiences a rise or fall in clients.

Often, if you go for a variable interest rate, you will get a better deal as you are risking the interest rate rising at different points during the equity release scheme.

There are pros and cons to fixed and variable interest rates, so this is something to discuss with an equity release lender as there is no right option that would suit everyone.

However, there is one suggestion we would give to all equity release customers who opt for a variable interest rate, and that is to always ensure there is a cap in place.

This is because you will at least be able to trust that your interest rate will not increase past a certain point. Otherwise, it could rise significantly until it becomes an unaffordable amount.

Though you do not have to make repayments on the interest anyway, so you may feel as though this doesn’t apply to you, it is best to keep the debt as minimal as possible to ensure you do not get into negative equity, and leave your family in debt.

When Does Interest Have to Be Repaid With Equity Release?

As we mentioned above, there is no requirement for equity release consumers to pay back the interest on their loan early. The interest is only due when the general loan amount is due, which is when the homeowner dies or goes into permanent care.

When this occurs, the equity release lender puts the house or flat up for sale and takes enough money to cover the amount of money the customer borrowed, including the interest that has racked up.

If the customer has not made repayments on the interest, and as a result they have borrowed an amount of money that surpasses the value of their property, they will be dealing with negative equity.

Some equity release lenders will expect the family of the homeowner to pay the difference, either through additional funds in the homeowner’s estate or by using their own money. This is one of the reasons we always recommend discussing equity release with your family; it may end up affecting them in a serious way.

However, nowadays it is very easy to secure a no negative equity guarantee. This means the lender promises to never ask your family to pay the difference, so once your home is sold, your family is no longer involved with the equity release scheme and they are not in any debt.

How Can I Avoid Growing Interest With Equity Release?

There is no way to avoid the interest that comes with equity release. Whether you make repayments or not, you will still have to pay the interest somehow.

However, you can reduce the build-up of interest (compound interest) by either opting for low-interest rates or repaying the interest. Here are some ideas.

1. Find an equity release plan with low-interest rates

Certain equity release plans offer low-interest rates, and if you find an equity release lender with low-interest rates, you can be paying less than the average equity release consumer.

However, it is important to remember that interest rates are changing all the time, so you need to check them regularly before diving into equity release.

What’s more, certain times of year are better for low-interest rates, and this tends to be the beginning of the year. We would advise customers hoping to access low-interest rates to release equity between January-March if possible.

Keep reading to find out what the lowest interest rates are with equity release, and which equity release arrangements tend to charge lower interest.

2. Get downsizing protection

If you secure an equity release plan with downsizing protection, it means you are able to move into a new property whenever you want to, and you will not incur an early repayment charge. So, how does this relate to interest?

If you found yourself paying a huge amount of interest and you had downsizing protection, you would be able to move into a new property, switch your equity release plan, and pay less interest.

You could either do this by moving into a lower value property, which would reduce your loan amount and therefore your compound interest, or choosing a plan with notoriously low interest rates.

A more extreme option would be to leave the equity release scheme in the past by repaying your loan, and therefore not owing interest beyond this point. If you decided to do this and you had downsizing protection, your lender would have to allow you to exit the scheme.

3. Get an interest only lifetime mortgage

One of the most common ways to manage compound interest is to take out an interest only lifetime mortgage and make repayments on the interest each month. Some people are in the position to repay the full amount each month, whereas others simply pay what they can.

Though this will not help you to escape the interest payments, it will ensure you are only charged compound interest on your loan amount and not on your annual interest payments, helping you to save money overall.

If you do not have any family to leave an inheritance to, you may decide to bypass this as it wouldn’t matter if your interest racked up to a huge amount, given that you wouldn’t have to repay it and you wouldn’t be alive to deal with the debt.

Another reason you may decide against this plan is that the amount of money you can release is calculated based on your retirement income.

This would not be an issue for people with a large income, from pensions, savings or employment, but anyone on a low income may be better off with a plan that allows them to take out more funds from their property.

The reason interest-only lifetime mortgages take into account retirement income, and other schemes do not, is that the lender needs to be certain that the homeowner will be able to afford monthly repayments on the interest.

This does not have to be full payments, but the lender and consumer will have to settle on a certain amount.

4. Get a voluntary repayment lifetime mortgage

Another option is to secure a voluntary repayment lifetime mortgage. Rather than repaying interest, this mortgage allows you to repay the loan itself. As it is involuntary, it wouldn’t matter if you went years without repaying the money.

This is great news for people who are not comfortable enough to get an interest-only mortgage and risk not being able to afford repayments, but who want to keep their debt to a minimum,

However, you would have the option to pay some money back if you were in a comfortable financial position. The more money you were able to pay back, the lower your compound interest would be as it is partially charged on the loan amount.

5. Get a Drawdown Lifetime Mortgage

With a drawdown lifetime mortgage, you get a lump sum of cash when you first receive your loan, but the rest of the funds are placed into a drawdown reserve. This means you can take the money whenever you want, but you are not obligated to.

If you select this option, you will pay less interest overall as you will only be charged interest on the amount of money you withdraw.

Of course if you end up withdrawing a significant amount, this doesn’t apply, but plenty of people get a drawdown mortgage and leave funds in the cash reserve for emergencies or for later life care.

6. Have a Home Reversion

Getting a home reversion plan is a definite route to not paying interest on your equity loan. Once you have sold your home to an equity release provider, you will receive a lump sum of tax-free cash with no interest whatsoever.

However, the trade-off for this is that you will no longer be the homeowner, so if the provider’s share of the property rises in value, it will not benefit you in any way.

Furthermore, as you sell your property for less than the market value, you may not get as much money from it as you would by selling it. However, you would be able to stay in your property for the rest of your life and access money that was previously tied up in your property.

What are the Lowest Equity Release Interest Rates?

The lowest equity release interest rate is currently recorded at 5.72%, but this is a fixed rate rather than variable.

The interest rates on equity release products will depend on which lender you are purchasing the product from. However, you can generally trust lump sum lifetime mortgages and drawdown lifetime mortgages for low interest rates.

Home reversions are the best in terms of interest, as they are completely interest-free. This is because you are not taking out a mortgage, but instead selling your home to the equity release provider.

What are the Highest Equity Release Interest Rates?

The highest equity release interest is currently 8.10%. You can expect higher interest rates like this from the enhanced lifetime mortgage, as well as schemes that allow you to borrow a large number of funds e.g. the second home lifetime mortgage or the buy-to-let lifetime mortgage.

Having said that, if you qualify for certain bonuses with the enhanced lifetime mortgage (due to disability or old age), you may secure a deal involving low-interest rates.

What are the Average Equity Release Interest Rates?

The Equity Release Council’s Spring 2021 Market Report found that the average equity release interest rate that year was 3.95%.

Remember that this is over many different equity release plans and many different lenders, so you will not necessarily be offered an interest rate close to 3.95%. This is because you can only rely on lenders who are currently available, who are willing to lend to you, and who have the right plans for you.

What Affects the Amount of Interest That is Charged?

Different factors influence the amount of interest you will have to pay with equity release, not just the lender’s criteria and the average interest rate on your chosen plan. Here are some examples.

1. Your Property Value

The higher your property value, the more chance you will be offered a low interest rate. The same applies if your property is not currently highly valuable but the lender predicts that it will increase in value over time.

This is because the lender has to gauge how property prices might change after you release equity, and they use this information to determine how risky it would be to offer you a loan. The less risk involved, the lower the interest rate will be.

2. Your Marital Status

If you are making a joint application for equity release with your partner, the age of the youngest partner will determine your eligibility for equity release. If the criteria is met, the amount of money you could release together will be partly calculated by the youngest homeowner’s age.

So, what does this mean for interest rates? Usually, older homeowners can borrow more from their properties, but this means higher interest rates. If your partner is younger than you, you may decide to make an individual equity release application to keep the interest as low as possible.

3. Your Age

As we have already mentioned, older homeowners are usually able to take more money from their property. This is because they tend to be on the scheme for a shorter amount of time, so the lender reaps the benefits of the scheme much faster.

What’s more, there is less chance the property value will decrease, so again, the lender gets more out of the deal.

However, borrowing more money does tend to mean you will have to pay higher interest rates, so you may want to consider releasing equity as young as 55 if you are not prepared to owe a lot of interest.

4. The Amount Of Money You Release

Again, we have mentioned this in describing the difference between a young homeowner and an old homeowner taking out equity.

However, it is worth reiterating that the more money you release, the more interest you will pay on it. Some people choose to release less money than they are entitled to to avoid the compound interest building as much.

5. Your Credit History

It is possible that homeowners with very poor credit scores will not qualify for plans with competitive interest rates. However, no one is ever ineligible for equity release entirely because of a bad credit history.

This is because homeowners do not have to prove they can reliably repay money, given that they will never be obliged to repay their equity loan while they are still alive.

Having said that, if a homeowner does have a particularly impressive credit score, they may be able to access a wider range of equity release arrangements.

6. The Product Features

Something to keep in mind is that you may end up paying higher interest rates in order to benefit from superior product features that are crucial to your experience of equity release.

For instance, if you are very determined to leave money to your family, inheritance protection may be non-negotiable for you, but many lenders who offer this will have higher interest rates.

Another example is that the equity release lender may offer a free valuation of your property. This means a surveyor would estimate the value of your home at no cost to you. However, they are likely to charge more interest if you accept this deal.

Something else to acknowledge is the fact that you may not be eligible to receive a loan from every single equity release provider on the market. This means you may have to make some compromises when it comes to interest, as your preferred lender may not approve you for a loan.

How Can I Find Out How Much Interest I Will Be Charged?

You can estimate how much interest you will be paying by speaking to one of our professional equity release advisers. They will ask you questions to determine which plan may be suitable for you, which lenders would be a good match, and using this information, they can estimate interest rates.

However, it is important to remember that you cannot discover exactly how much interest you would be paying until you get in touch with an equity release adviser.

They will be able to propose an interest rate based on their available plans, their lending criteria, their product features, your property value, your age, your marital status, and various other factors.

Are Equity Release Interest Rates Rising Or Falling?

As equity release became more popular and more modern, the interest rates for lifetime mortgages started to fall. You will still find many articles discussing equity release interest rates being at an all-time-low.

However, in July 2022, the average interest rate for equity release was 5.63%, which is the highest it has been in six years (2).

To demonstrate the severity of this, at the start of 2022, the average rate was just 4.10%. Evidently, equity release interest rates are rising again.

This is concerning many homeowners, which is evidenced by the fact that, in 2021, the Financial Ombudsman received 208 complaints from equity release consumers about the compound interest on their equity release plans (3).

In 91% of cases, the Ombudsman determined that the equity release lender was not at fault. This is because homeowners should research equity release before committing to it, and this includes looking into how they will be affected by roll-up interest.

What Happens If I Take Out an Interest Only Lifetime Mortgage and Cannot Afford it?

You should only ever take out an interest only lifetime mortgage if you are confident that you will be able to repay the interest each month. If you are cash poor and you are using equity release to help make ends meet, this will most likely be an unsuitable equity release arrangement for you.

In the event that you have already enrolled onto this plan and you cannot afford to make repayments, we would advise speaking to your equity release lender and asking if it would be possible for you to switch plans, or even to significantly reduce the amount of monthly interest they are charging you.

However, if you are a new equity release customer, taking our advice from the beginning will prevent this situation from ever occurring.

Any ERC-regulated equity release adviser will tell you to avoid the interest only scheme unless you can prove that you have enough funds to pay back some or all of the interest.

What’s more, most providers of retirement interest only mortgages will perform affordability checks to ensure that you will definitely be able to make repayments on the interest. This means you will not even be permitted to enrol onto the plan unless you are in the position to afford it (4).

Getting an Equity Loan With Equity Release Warehouse

Equity Release Warehouse will help you to secure the best interest rates with equity release. We do this by offering a free telephone consultation, in which we learn all about your personal situation and determine what your interest rate may look like with this scheme.

We also research local equity release lenders to compare interest rates and eligibility criteria. If you are after the lowest possible interest rates, we can help you to access this.

However, we will also encourage you to think about equity release more broadly, which involves deciding whether higher interest rates may be worth it in exchange for other benefits.

Please remember that this is your decision at the end of the day. We may make suggestions for better interest, such as making a single application instead of a joint one, releasing equity at a young age, or borrowing less money.

However, you are more than welcome to ignore these suggestions if you do not believe they would benefit you. We are not here to pressure you into doing equity release a certain way, but instead we want to make sure you have considered all of your options.

This includes discussing the alternatives to equity release if you are interested in this. Some homeowners would benefit from a different scheme such as downsizing. You do not have to make a decision over the phone, as we will simply outline your options and give you the time and space to make a decision.

To speak to one of our advisers about equity release interest rates, give us a call on 0330 058 1579 or head to our callback form and fill in your details for us. On the call, we will explain all things equity release, but be sure to make it clear that you would like to focus on interest rates.

References

[1] What Is Interest? https://www.thebalancemoney.com/what-is-interest-315436

[2] Equity release mortgage rates hit six-year high with average interest at 5.63%: Here’s how to make sure you get the best deal as costs rise https://www.thisismoney.co.uk/money/equityrelease/article-10980413/Equity-release-mortgage-rates-hit-six-year-high-average-5-63.html

[3] Equity release loans surge as older homeowners raise funds https://www.ft.com/content/7c5f166c-a9d6-4398-bb89-e4828d4114f4

[4] Retirement interest-only mortgages