Throughout different times in life, homeowners might explore the idea of remortgaging to release equity in their home. By accessing the money, they can then spend the money on home improvements, clear any loans, or maybe even purchase a caravan or a once-in-a-lifetime holiday.
In recent years, there has been an increase in the number of homeowners aged 55 and over that are looking into the possibility of equity release by taking out a lifetime mortgage or a home reversion.
Choosing to release equity in your property is a huge financial decision, so it is important to be fully clear about the process and understand all of the drawbacks, as well as the advantages. In this guide, we look at everything you need to know about equity release to help you to make the decision that is right for your specific situation.
What is equity release?
Equity release enables homeowners to access money based on the value of their property without selling it. Equity release is a financial product that mortgage providers offer to homeowners aged over 55, so that they receive a lump sum of money (or smaller, regular payments) in exchange for a repayment agreement.
The different types of equity release explained
There are two different types of equity release products available on the market and one might be more suitable for your needs than the other, so we’ll explain the key differences:
This is the more common form of equity release and it is based on an agreement that you are provided with a sum of cash and the amount, plus interest is paid back either when you pass away or go into care. Like with most mortgages, different rates and fees are available from different companies.
Some lifetime mortgages offer the opportunity to make interest repayments rather than let the interest accumulate, which might suit people that are worried about how much a lifetime mortgage will reduce their family’s inheritance. You also have the choice to set the amount of the property’s value that you want to be paid as inheritance, to ensure that your family gets that sum when you pass away.
This type of equity release involves selling part or all of your property to the provider in exchange for a lump-sum payment. You can alternatively agree to take regular payments, rather than a lump sum. You are still able to live in your home but it will be owned, or partially owned, by the home reversion provider. Where you choose to sell part of your property, this will be agreed as a percentage and that proportion remains the same, despite any value fluctuations.
Similarly to the lifetime mortgage option, you are able to set an amount of the property value to be attributed to inheritance. When you pass away, the property gets sold and the money will be split according to the agreement.
How much equity can be released?
Generally, the amount of equity that people arrange to be released is between 20% and 50% of the property value. The lender will get your property valued by a surveyor and use your age and health as indicators of your life expectancy to decide how much they are prepared to lend to you.
What are the benefits of equity release?
There are many different reasons that homeowners decide to release equity in their home but generally, it is to provide them with more financial freedom. Just like the purposes of taking out loans varies greatly from one person to another, equity release can benefit people in a number of different ways such as:
- Providing financial support to your family instead of them waiting to receive an inheritance.
- Paying off loans and any other debts.
- Being able to live a higher standard of life, for example, taking more holidays.
- Making improvements to your home, such as an extension, new kitchen, or a bathroom that is more suitable for using as you get older.
- For a big purchase like a car or a caravan.
- To live without worrying about paying bills or any other financial concerns.
- Reduction in inheritance tax.
For those who want to make sure that they are able to enjoy their retirement years and not feel any financial burdens, equity release provides that opportunity. Financial advisers often recommend equity release as a way to avoid paying huge amounts of inheritance tax but must provide calculations on the projected interest over different lengths of time.
In the UK, people are currently taxed 40% on any inheritance above the threshold of £325,000, so by taking out a lump sum before you pass away, rather than leaving that amount as inheritance, the tax is avoided. However, you must also think about how much interest you will end up paying and whether it could end up being more than the tax.
What are the fees involved with equity release?
Fees vary massively from one company to the next but at Boon Brokers there is a client fee of £595 to arrange the equity release service. As shared by moneyadviceservice.org.uk arrangement fees can reach between £1,500 and £3,000, so Boon Brokers’ fee is in the lower end of the market.
As an example, Age Partnership charges 1.95% of the amount released, which on an amount of £100,000 would be £1,950. Working with a broker will generally give you access to more deals and there is quite a bit of work involved in finding deals through different lenders, so using a broker makes the process much easier and stress-free. You should also make sure that any company that you work with is a member of the Equity Release Council, for your protection.
The typical rate that you will pay, according to Martin Lewis, is 5%. However, this amount depends on your circumstances, just like with standard mortgage rates. You will find rates ranging from about 3% up to 7% but only a small percentage of people will qualify for the really low rates.
Factors that influence the rate that you will be entitled to include your age, health, property value and lump sum amount. Other costs that are applicable are legal work, advice and surveyor fees.
Why would you want equity to be released?
As mentioned above, the avoidance of inheritance tax is a big motivation for many people but that must be weighed up in relation to how much the interest fees could amount to over many years. The benefits we listed above, such as paying off debts, having financial freedom or making a big purchase are all reasons that people want equity to be released.
With pensions not as favourable as they were historically and people living for longer, many people need to access money to support their later years once they have retired. Many mortgage lenders have age limits that prevent people from taking out remortgages as they get older, so equity release is the most suitable alternative.
Releasing equity enables homeowners to stay living in their home, as opposed to needing to sell their property and buy somewhere smaller and cheaper. It is common for retired people to downsize once their children have moved out of the home but not everyone wants to leave their family home, so equity release is a better solution for them. Moving home can be a very distressing process, especially as people get older or have health problems, so equity release prevents them from going through the upheaval.
Moving home may also leave pensioners needing to pay stamp duty when they buy a new property if it is over the stamp duty threshold of £125,000. Therefore, some will prefer to stay in their current home to avoid paying the stamp duty.
For homeowners that do not have any children, other relatives or people that they want to leave their estate to, equity release is a way of getting hold of money that would otherwise be left to the government. It means that they get to spend the money that they worked hard for when paying off the mortgage.
Many lenders also offer a ‘no negative equity guarantee’, which means that if property values drop and a house value drops into negative equity, the lender takes the hit and not the homeowner. The current low rates that are available also make this option more appealing in this financial climate.
If you release equity to provide financial support to your family, you will get to see the impact it has on their lives and the happiness that it brings. Having that money available earlier in their life could mean that they get to live a better quality of life for more years, maybe paying off their own mortgage, or paying education/tuition fees, for example.
Where there is an illness in the family, being able to provide private healthcare could significantly improve the person’s healthcare options, rather than being on a waiting list for an operation.
You could choose equity release as a solution to having in-home care rather than going into a care home if that is a scenario that you want to avoid. The money could be used to adapt your home as well, to ensure that you can comfortably live there.
Being able to enjoy life to a fuller extent and take holidays may extend your life by improving your health, living without the stress of paying bills and by having no financial worries. If you have always wanted to go on a specific holiday to a certain destination then you can realise that dream before you pass away.
Who can have equity released?
Homeowners over the age of 55 are eligible to release equity and whilst some companies will want you to have paid off your mortgage completely, not all providers do. Also, some lenders will only lend to people over 60 years old and it is the age of the youngest homeowner that is taken into account.
Your home must be in the UK and homeowners in the Isle of Man are not eligible for equity release. Most lenders will only provide their equity release service for properties that are valued over £70,000. There are also maximum property value limits imposed by some lenders.
The minimum amount that you are able to loan on a lifetime mortgage is £10,000, so if you only require a smaller amount, you will need to look at other options. Many lenders will perform credit checks and may not provide services to those with a poor credit history, despite the fact that your property is the security for their loan and monthly payments are not required.
When shouldn’t you release equity?
The big disadvantage of equity release is that it involves compounding interest, so the amount of interest escalates very quickly. Over a period of 15 years, debt will generally have doubled, so it can end up being very costly.
As you are not paying off interest monthly as you would with a standard mortgage, the interest just builds up until you pass away or go into care. Whilst it will not be you that is paying back the interest, as you will no longer be around, your will beneficiaries could lose out on a lot of inheritance.
People that are entitled to certain benefits can be affected by taking a lump sum of equity. For example, pension credit and any other means-tested benefits could be lost or reduced.
It is important to remember that this is a permanent agreement and that trying to switch to better rates is not an option due to the typical early repayment charges of around 25%. There is also the issue that once you release equity, you are not able to take out any other loans against the property.
The average life expectancy in the UK currently stands at 82.9 years for females and 79.2 years for males. Therefore, if you take out a lifetime mortgage at 55, the average person will live for at least another 25 years. The interest that compounds over that length of time will be very significant, so you need to take that into account if your main reason for considering equity release is for inheritance tax avoidance.
If you opt for selling your home to a reversion company and your property value rises in the future, it would be the lender that profits from that and not you or your beneficiaries.
Is equity release the right option for you?
Like any financial decision, you must weigh up all of the pros and cons before deciding whether it is the right option for you. If you stand to lose benefits then it could be the wrong move for you and it is a decision that is very difficult to reverse without huge financial penalty.
If there is a specific need for money, for example, to pay for private medical bills, or another unexpected cost arises then equity release may be the most suitable option. If you are in good health you could live for many years, with the interest accumulating all of that time and potentially reducing the amount of inheritance that your family receives.
You should consider all of the available alternatives, such as taking a short-term loan out or downsizing and moving into a smaller property to release some funds. You could even consider selling your property and renting a home so that you can access the money tied up in your property.
Sometimes expenses that you never planned for will appear and you simply need to get some money to deal with them. If your options are limited because you are retired, equity release might be your only way to get by.
If your main priority is to live as comfortable a life as possible, rather than leave an inheritance, then equity release is definitely a way to achieve a better quality of life. For some people, working all your life to pay off a mortgage and then not being able to enjoy retirement to the extent they could, feels unfair. They are then able to release equity and live their dream retirement, filled with nice holidays, hobbies and other lifestyle costs.
Tips for equity release
If you are considering equity release then here are some tips to help make the right choice for you:
- It is better to borrow smaller amounts over time, rather than take one full lump sum, as the interest that accumulates will be less.
- You might want to consider an equity release option that allows you to make monthly interest payments to prevent the escalating interest costs.
- Working with a broker will help you to find some of the best available rates.
- Only borrow the amount that you need, don’t be tempted to take the maximum just because you can.
- Do the necessary research to check whether any of your benefits will be affected, or take independent financial advice to help you to check this.
- If possible, go for an equity release product that does not have an early repayment charge, so that you are not tied down forever.
- Only consider lenders that are members of the Equity Release Council, to ensure you are covered by their protection.
- Shop around for the best rates, as even a small difference in percentage rate will make a big difference over many years.
- Remember that even though equity release can avoid or reduce inheritance tax, the actual cost of the interest could end up being more than the amount your estate would have been taxed.
- Consider all of the alternative options, as equity release is more permanent than most other solutions.
- Remember that this will impact the beneficiaries of your will, so it might be a good idea to discuss it with the people affected, to avoid confusion and to explain your decision. However, it is your money and you are entitled to do what you wish with it.
- Choose a company that provides a no negative equity guarantee.
- Check that you are able to transfer the arrangement onto another property, in case you move in the future.
Equity release is becoming more popular as people over 55 are choosing to take up the opportunity of complete financial freedom and the opportunity to enjoy the money whilst they are alive. Whilst it is a very good option for many people, it is important that you fully consider the implications of choosing to release equity. You must consider the impact that it will have on your will beneficiaries before you make the decision.
There are many alternative options that you should give consideration to, from downsizing and moving into a smaller property, to taking out a different type of loan. What people tend to overlook is that compounded interest quickly mounts up, which can sometimes end up costing more than inheritance tax would have been. Therefore, it is a good idea to calculate the amount that it would cost when you live beyond the average life expectancy to evaluate the impact on your family.
Unlocking the value of your property could completely change your life, or bring significant improvements to your family’s future, so it is easy to see why so many people are choosing to release equity.
If you do choose equity release, it is really important to select a lender that is in the Equity Release Council, to ensure you are protected by their code of conduct. Finally, never rush into this important, long-term decision, take your time and get expert advice before you commit to any arrangement.
Gerard is a co-founder and partner of Boon Brokers. Having studied many areas of financial services at the University of Leeds, and following completion of his CeMAP and CeRER qualifications, Gerard has acquired a vast knowledge of the mortgage, insurance and equity release industry.