The mortgage market has courted controversy over the years – from endowment policies that failed to cover interest only mortgages to equity release horror stories.
In the back of a borrowers mind there always lingers the question – what if something isn’t as it seems or goes wrong?
It is always good to be cautious when entering into a mortgage, not least because it is likely to be the biggest financial commitment you will make in your life.
But how cautious should you be with equity release and is there any truth to the negative publicity that often shrouds equity release?
This guide breaks everything down, looking at the good, the bad and the ugly of equity release to help you make an informed decision before proceeding.
The Different Types of Equity Release
There are currently two forms of equity release product available in the UK.
Both types of product are highly regulated and on a basic level you should rest-assured you will have some protection when taking an equity release.
The first and most common form of equity release is the lifetime mortgage.
This product allows you to borrow money that is secured against your property.
The lender collects the payment for the mortgage when you die or if you go into long term care.
Home Reversion Plan
The home reversion plan is a less used form of equity release but can be suitable in certain circumstances.
With the home reversion plan you actually sell the entirety or portion of your house and raise money from the sale.
You then make contributions to the equity release company to reside in the property until you die or go into long term care.
When you have a consultation with an equity release broker, they will explain both products in much more detail and advise which option is best for your circumstances.
History of Equity Release Gone Wrong
As you can probably imagine, the products above have plenty of scope to go wrong and like traditional mortgage products, equity release also carries a level of inherent risk.
Historically, equity release was an area of the mortgage market that didn’t have as strict controls as it does today – the reduced controls inevitably attracted lenders who were unscrupulous.
Below are some of the common areas of equity release that draw negative attention to the product.
In the UK, our life expectancy is increasing over time. That means that more people are living longer and the demand for healthcare in later years has increased as a result.
With an equity release product, you will still have an interest payment that rolls up over time if you decide not to make any voluntary mortgage payments.
In simplest terms, the longer you live with an equity release product, the longer the time for the interest to accrue.
Some equity release products will leave people in negative equity when they die or go into long term care if the amount of money outstanding on the mortgage outweighs the value of the property.
This can prove devastating as after the property is sold, your next of kin could be lumbered with a substantial bill to pay.
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We mentioned that the interest on equity release products typically ‘rolls-up’.
This means that you have interest charged on the interest you have already accrued.
Compounding interest can cause your borrowing to grow at a much faster rate than a standard interest rate structure.
This fast rate of growth on the debt increases the risk of being in a negative equity situation.
Early Repayment Charges
If you take an equity release product and change your mind, opting instead to pay it off before you die or go into long term care, you might be faced with early repayment charges.
Early repayment charges are essentially a financial penalty imposed by lenders to settle the debt before it is due.
These charges can be substantial and people facing them often feel that the charges are not particularly fair.
The reason lenders impose early repayment charges is to ensure that they make a profit on the loan.
The interest calculated at the time the product was taken reflected the risk of that mortgage and allowed the lender to budget how much to expect in terms of profit.
If you opt out of the product early the lender hasn’t necessarily recouped enough money to make the product worthwhile for them – so they can impose early repayment charges to try and bump up the return on the mortgage.
Lack or Total Loss of Inheritance
This element of equity release often gets the most bad press.
Sometimes people find that the inheritance they receive after someone dies is greatly diminished or non-existent because the money in the estate has gone to paying off the equity release product.
Unfortunately, the nature of borrowing on equity release will always devalue an inheritance to some extent. In most cases though you can get a rough idea of how much it will devalue an inheritance.
With no-negative equity guaranteed products you know that the inheritance will never be impacted beyond the value of the property you’re mortgaging against.
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Should This Put You Off Equity Release?
The answer to this question is multifaceted and it really comes down to your desires and your personal financial situation.
For example, if you want to leave your the entire value of your property to your next of kin, then equity release is not a product that would be suitable for you.
But with that said, there are many reasons why equity release could be invaluable to you and with increased controls and responsibilities adopted by lenders and brokers, you have much more protection today than you would have had historically.
The biggest changes to the equity release market were bought brought about by the establishment of the Equity Release Council (ERC). The standards implemented by the ERC make equity release products much more palatable and, in most cases today, enticing.
The ERC and Industry Changes
Due to the prevalence of poor customer experiences around equity release, the Equity Release Council was established to become a vanguard of standards across the equity release market.
One of the primary goals of the ERC was to establish trust in equity release and maintain a set of high standards across brokers and providers.
Membership of the council is voluntary and according to the ERC, 90% of providers are currently members.
This is important because there are key benefits provided by ERC members that non-members don’t necessarily provide.
ERC members commit to providing equity release products that have:
- A no-negative equity guarantee
- The ability to move home/port equity release product to a new property
- Lifetime mortgages have a fixed interest rate (if they have variable interest rates there must be a cap in place)
- The right to remain in your property until you pass away or require long term care
- The right to make penalty free payments against the mortgage
As mentioned, the industry on the whole has embraced the standards outlined by the ERC but 10% of the market doesn’t currently adhere to the ERC requirements.
This means there are still equity release products on the market that are less than reputable.
In order to ensure you’re getting the standards mentioned you should ensure your broker and provider is a member of the Equity Release Council.
Pros of Equity Release
Equity release can be an extremely useful product for anyone over the age of 55.
It allows you to borrow money against your home and release the funds tied up in the equity of your property. Let’s explore these benefits in detail.
Flexible Use of Funds
A key benefit of Equity Release is its flexibility. You can use the funds from equity release for any legal reason and there are no restrictions on how you spend the money.
Common reasons people use equity release are:
- Buy a new car
- Buy a caravan
- Gift children money (early inheritance)
- Gift children deposit for home
- Raise funds for a deposit on a second property
- Holidays such as cruises
- Budgeting additional finance in later years
Sometimes older people find that they’re asset rich but don’t have much in the way of immediate cashflow. When you take an equity release product you can draw the funds as one lumpsum or regular payments – you can even opt to take a combination of both.
With regular mortgages, mortgage payments are required on a monthly basis.
If you do not meet those payments with regular mortgages, your account will default and this could ultimately result in a repossession of your home if defaults continue.
Whereas lifetime mortgages (equity release) provide the ultimate flexibility as they allow you to make payments as and when you see fit, if at all.
You have the flexibility to service the interest monthly, pay off a portion of the capital (normally up to 10% of the outstanding mortgage balance per annum) or not pay anything at all.
If you decide not to make any monthly mortgage payments, the interest will compound but your account will not default and your home will never be repossessed.
Permanent Rights to Reside
With Equity Release products approved by the ERC, you have permanent rights to live in your property until you pass away or move into long-term care. This
If you own the property jointly with another person and are both named on the lifetime mortgage deed, the equity release product will only need to be redeemed once you both pass away or move into long-term care.
No Negative Equity Guarantee
Again, as long as the Equity Release Product is approved by the ERC, your Equity Release with have a No Negative Guarantee.
This means that you cannot owe more than the value of your home.
For example, in the unlikely event of the economy crashing in the short-term, resulting in significant deflation across the property market, some homeowners may find that they owe more than the value of their homes.
With ERC approved Equity Release products, the surplus amount is written off by the lender so you do not need to worry about owing more than the value of your property.
Tax Implications of Equity Release
Equity release funds can be paid in a lump sum, tax-free.
Equity Release will not have any impact on Capital Gains or Income Tax.
As Equity Release is technically not an income as it is a loan, it is exempt from income tax.
The most significant area of tax that we typically discuss with our Equity Release clients revolves around Inheritance Tax.
With inheritance tax, the threshold for an individual is currently £325,000. Your Equity Release Lifetime Mortgage will be directly offset from the value of your estate, like any other mortgage, which will reduce your inheritance tax liability.
There are many other benefits of taking out Equity Release. If you would like a free consultation on your specific circumstances, contact one of our advisers at Boon Brokers today. We would be happy to assist.
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Cons of Equity Release
Of course, there are also some drawbacks with equity release.
First and foremost, if you’re looking to leave an inheritance to your next of kin you will find that equity release does diminish the amount you can leave.
That doesn’t mean that the inheritance you wish to leave will be eroded completely and if you have funds outside of the property, you will protect those by using a no-negative equity product.
Furthermore, you don’t need to borrow the full amount available to you when releasing equity and this can sometimes mean there is something left over when the property is sold for inheritance purposes.
You will also find that if you opt to use a lender or broker that is not a member of the ERC you could be exposed to some of the negative aspects mentioned at the beginning of this guide.
Misconceptions About Equity Release Today
The biggest misconception about equity release today is that it is the product that has so many negative connotations attached to it from the old days.
Once again though, it is important to realise that the lenders and brokers who aren’t members of the ERC can still represent the equity release horrors of yesteryear.
This is because companies that don’t subscribe to ERC oversight can have products that:
- Leave your estate in debt after the property is sold.
- Be tied to your property and not be able to move or downsize.
- Face financial penalties that you wouldn’t have with an ERC product.
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The Truth About Equity Release Today
For equity release that meets the ERC standards you will find the products are designed in a way to be flexible, fair and reputable for customers.
ERC products offer a number of protections to borrowers that go above and beyond the products that aren’t required to meet ERC requirements.
That means that most lenders and brokers on the market today (90%) offer equity release products that are responsible and created with the customer in mind.
Equity release as a product has had a difficult history, especially in the past where poor products have been commonplace.
Today, most of these predatory products and lenders no longer exist – however you should still approach equity release with a degree of caution.
Specifically, you should seek a product, lender and broker that meet ERC standards.
These standards were implemented to protect customers and provide extra rights to those taking equity release.
Today equity release is a highly regulated industry and with the standards implemented by the ERC it is bolstered further for customers.
Boon Brokers is a member of the ERC and maintains both the regulatory standards for equity release set out by the Financial Conduct Authority and the additional ERC requirements.
Boon Brokers is a whole of market mortgage, insurance and equity release broker.
Our brokers have whole-of-market access and do not charge any client fees.
We have expertise in arranging equity release products that meet the highest market standards.
Call Boon Brokers to discuss your equity release goals (or concerns) today.