How Does Equity Release Work?

Equity release can be defined as a way of unlocking property value. A property owner (i.e., homeowner) can use equity release to get money from the value of their home. There are policies in place that allow property owners to access or “release the equity in their homes.

This option is reserved for a wide range of individuals, including those who are 55 years and above, as well as those who haven’t paid off their mortgages.

The money that is “released” can be taken as one lump sum and/or as many small amounts on which interest is paid. While equity release is a great way of getting cash, it must be done the right way; otherwise, it can turn out to be very costly.

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How does equity release work?

Equity release works in several forms. It can take the form of a mortgage loan that is never paid off until the borrower dies. There are other finance options to consider if you have dependents who you’d like to leave an inheritance.

If it’s just you, it is a great way to raise cash. However, it can be expensive. The two main equity release options are:

1. Lifetime mortgage

This equity release option is incredibly popular among homeowners aged 55 and above.

If you take a lifetime mortgage as an equity release “vehicle”, you borrow a percentage of your home’s value for a fixed interest rate.

Lifetime mortgage borrowers don’t make repayments when they are alive. Interest compounds fast as the loan amount increases constantly.

It may be possible to repay interest and a portion of the capital to reduce overall costs. In such an instance, you get to borrow money out of your home value in small amounts periodically with interest charged only on the amount taken as opposed to the entire loan amount.

Like typical mortgages, lifetime mortgages vary depending on a lender. Before you take out a lifetime mortgage, it’s important to consider the information below:

• There is a minimum age requirement for taking a lifetime mortgage – 55 years in most cases. Taking a lifetime mortgage as early as possible results in higher costs in the long run
• There are borrowing limits – typically 60% of your home’s value or less
• The amount that will be released to you depends on factors like your age as well as the property value. The percentage of money you get increases with age. Other factors include past/present medical condition. Individuals with a history of medical problems may get more from some lifetime mortgage providers
• Lifetime mortgages come with fixed interest rates. If the rates are variable, they must be capped (have an upper limit)
• Borrowers are the rightful owners of their property for life. However, this may be subject to some conditions i.e., borrowers must abide by all contractual terms and conditions. In most cases, the property must remain as the borrower’s main residence
• Borrowers reserve the right to move subject to the new home being accepted by their mortgage provider as security for the equity release loan. However, different lenders may have different thresholds.
• When you take out an equity release using a lifetime mortgage, the product doesn’t have negative equity guarantee. This means, once your property is sold, you/your estate won’t be liable if there is a balance after the property is sold
• Making repayments reduces the cost of the mortgage loan. You can repay an amount that matches your income. Your provider should help you assess if you can afford repayments
• You can withdraw your loan in small amounts or as a lump sum. Withdrawing in small amounts is advisable since interest will only be charged on the small amounts withdrawn

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2. Home Reversion

You can also access equity release through a home reversion plan. You should be 65+ years to access this option.

In a home reversion plan, providers give borrowers a tax-free lump sum in exchange for a portion of a borrower’s property below market value. You can live rent-free until you pass on.

When property is sold, proceeds are distributed based on the agreed percentage. If your home increases in value significantly, the share entitled to your next of kin will also increase and vice versa.

Example: If you sell a 40% stake in your £100,000 home for a £20,000 lump sum, you release your 40% stake at a huge discount compared to the actual worth (£40,000), mainly because the lender may have to wait for years to get their money. When you pass on, and your home is sold for £200,000, the provider will receive £80,000 (40% of the selling price). Your next of kin/family will be left with £120,000.

You can sell part or 100% of your home in return for regular payment or a lump sum. Before you take out a home reversion plan, it’s important to consider the information below:

• The minimum age for getting a home reversion plan is higher (above 60 years)
• The loan amount you receive increases with age. However, it can vary depending on the home reversion plan provider you choose
• You reserve the right to stay in your home for life or up until when you want to move out to long-term care. However, you must follow all terms and conditions
• You can move out as you wish as long as your provider accepts the new property as continuing security
• Home reversion plans don’t have negative equity guarantee. If the property is sold and the amount recovered from the sale isn’t enough to pay for the outstanding loan, you/your estate won’t be liable to settle the difference

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How much will equity release cost?

Typically, a lifetime mortgage equity release costs about 5%. However, some may be as low as 3% or less. While this may be cheaper than the rates in the recent past, they are still higher than standard mortgage rates. If you aren’t making any monthly repayments, the interest can compound quickly.

Example: If you borrow £30,000 at 5% when you are 60 years, on a £150,000 home, if you live till 80, you’ll owe £60,000.

You may also accumulate other fees in the process i.e., arrangement fees. They can range from £1,500 to £3,000 depending on factors such as the plan in place.

Other fees to consider include; legal fees, surveyor fees, and application fees. The precise cost of equity release can only be established on an individual case basis with a lender.

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Should I take a lump sum or small instalments?

You should take out amounts on a need basis. Smaller instalments are advisable because interest is only charged on those amounts, as opposed to the entire loan amount. Borrowing little by little as the need arises, and waiting until you must borrow will save you a lot in interest repayments.

Example: If you need £50,000 from your home over the next 10 years, take only what you need for a year i.e., £5,000, and take the rest periodically as the need arises.

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Should I deal with a company that isn’t an Equity Release Council member?

While you are free to choose whichever provider you like, it’s advisable to deal with Equity Release Council member providers only for several reasons. The most notable is – Equity Release Council exists to ensure equity release products are 100% safe and reliable.

The body sets the principles and standards of its members, reducing the risks associated with equity release products i.e., overpricing and negative equity guarantee. Using a member provider will ensure your estate never owes more than your home value. You also enjoy other benefits, such as independent legal advice.

Should I get advice before considering equity release?

Absolutely! You should speak to independent mortgage brokers, financial advisers, among other financial experts before you get into any financial deal. It’s also important to seek legal advice. Equity Release Council offers advice on equity release. You can also get advice from other independent institutions.

You need a solicitor to conduct legal work relating to your equity release. Your solicitor should explain all details regarding your plan, including your rights and obligations as well as those of the provider.

He/she should give a recommendation and sign a certificate verifying that the rights and obligations of the plain have been explained to you (the borrower), and you wish to proceed.

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Will equity release affect my benefits?

In some instances, having cash instead of property can alter the benefits you are entitled to i.e., universal credit, pension credit, and others. It’s therefore advisable to check how different plans will impact your benefits first before you make a final decision.

Is equity release more expensive than an ordinary mortgage?

If you take a lifetime mortgage, you will incur higher interest rate charges than you would with a typical mortgage. Equity release debt also tends to grow faster with rolled-up interest. While the value of property tends to increase over time, your provider must include safeguards in the contract just in case the property value drops. This explains the higher interest rate charges.

Borrowers should insist on safeguards themselves i.e., no negative equity guarantee as well as a fixed rate for life to avoid expensive repayments at the end of the contract period.

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When can the terms of my lifetime mortgage change?

Generally, lifetime mortgages come with flexible loan terms or the date when your loan is supposed to be repaid. The interest rate also remains fixed throughout. However, if you decide to borrow more, the rate can change for that specific cycle of additional borrowing. Terms can also change if you move homes. If you follow the terms of the plan to the letter, everything should remain the same.

Why is my home undervalued in-home reversion plans?

Home reversion plans are structured to offer lower market value estimates compared to the actual selling price on an open market for risk management purposes. Since loan repayments happen after decades, providers must use other means to secure their investment i.e., using lower property values and higher interest rates.

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Can I use my home to borrow more money elsewhere later in my retirement?

Once you release the equity in your home, you can’t rely on your home for money in the future i.e., when you want to pay for medical or long-term care costs.

When should I repay part of my lifetime mortgage?

If you have a next of kin, you may want to repay part of the loan or the entire loan to ensure they are left with something as an inheritance. While you can move to another house and transfer your lifetime mortgage, if you downsize, you may not have adequate equity to make such a move. This may force you to repay part of your mortgage.

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Is equity release good for me?

You should consider your income, age, the amount you need, and your future plans before you decide to release equity. Borrowers are advised to overlook short-term temptation of immediate cash and instead focus on the impact of releasing equity on your future and the future of your loved ones.

Where should I seek advice on equity release?

As mentioned above, the importance of professional advice can’t be overlooked before you consider equity release products. Professional advice is critical for finding the “perfect” plan for you. Before choosing a provider, make sure they are in the FCA register. Your financial adviser should help you with this.

FCA registration is a testament of compliance with the highest lender standards. FCA registered firms also have mechanisms for reporting and solving complaints. Financial advisers can also help you choose providers that are members of the Equity Release Council. Members of ERC must abide by strict industry rules and standards going beyond basic regulatory requirements.

Before you choose an equity release product, find out how much they charge in interest, what products they offer, and other related costs i.e., setup, valuation, and legal costs.