When it comes to retirement, it can be challenging to know all the options available to you. While you may have some kind of pension set up, it can be a struggle to have enough cash to enjoy your retirement how you want to. There are a number of ways of raising money in retirement, with equity release being one of the most popular choices for many.
Equity release definitely isn’t a decision to be taken lightly, so before making any choices on your retirement funds make sure you properly understand what equity release means, how it works and what other options you may have.
What is equity release?
Equity release allows you to access the cash, otherwise known as equity, that is tied up in property that you own. It is available to anyone over the age of 55 and allows you to take money as either a lump sum or in several smaller payments.
It offers those in retirement a way to unlock the value of your home and turn it into cash that you can spend how you please. It isn’t necessary to have fully paid off your mortgage, and you won’t have to move to release the equity from your home. In most cases, the older you are, then the more money you can release from your property.
Equity release schemes are available from many different providers, and it is essential to choose the right option for your situation as it is a lifetime commitment that can be very expensive. Many people use them to cover unexpected expenses or make up for shortfalls in their pension, but it can be a very costly solution.
Equity release allows you to access the wealth that you have accumulated in your property over the years, without having the hassle of trying to sell it and move home.
Equity release is available to any homeowners over the age of 55, and usually you will pay interest and not repay the debt until you have passed away. This means that the earlier you start with equity release, the more you are likely to pay in the long run.
What are the types of equity release?
There are two different choices for equity release available today, and you should properly understand your options before making a final decision on how to release money from your property. The two types of equity release are:
A lifetime mortgage allows you to take out a mortgage that is secured against your property. It is only available if the property is your primary residence and choosing a lifetime mortgage means that you will retain ownership while also releasing some equity. It is possible to keep some of your property’s value as an inheritance for your family.
You will have the choice of either making repayments or allowing all the interest to roll up over time. After you die or move into long-term care, the loan amount plus interest will need to be paid back. This is the most popular type of equity release as it allows you to borrow money against the value of your home while continuing to live in it without making any repayments. When the property is sold you can pay back the full debt, but this can mean that you are leaving less inheritance to family and loved ones.
A home reversion plan means that you sell all or part of your property to your selected home reversion provider for either a lump sum or regular smaller payments. You will still be able to live in your home rent free for the remainder of your life, but you do have to keep it well maintained and insured.
It is possible to ring-fence a percentage of your home’s value for later use, such as inheritance. The percentage amount that you choose to retain will always stay the same even as property values change. You can also decide to take further cash releases from the retained percentage, should you need additional funds in the future.
At the end of a home reversion, your property will be sold, and the proceeds of the sale are shared according to the remaining proportions of ownership. In most cases, home reversion will give you less than market value for a percentage of your home but does allow you to remain living in the property for the remainder of your life or until you move into residential care.
Home reversions usually allow you to release a higher amount of equity than a lifetime mortgage, but you will receive less than full market value for the percentage of your property that you sell.
How does equity release work?
Equity release is often confused and misunderstood, and as it is a lifetime commitment, it is important to get it right. A lifetime mortgage is the most common type of equity release, and this is how it works:
- When you choose a lifetime mortgage, you are choosing to take out a loan secured against your property. You must be a UK homeowner and over the age of 55 to get a lifetime mortgage.
- You can release some of the equity that is tied up in your property tax-free, while also continuing to live there.
- Equity release allows you to choose either a one-off lump sum or a small amount upfront and then further smaller payments as you need them.
- The amount that you can borrow against your home is dependent on your age, your health and the total value of your home.
- There are no monthly repayments to make as with most loans, as instead the interest is added to the total loan amount annually.
- The amount borrowed plus any accrued interest is repaid using the proceeds when your property is sold. Usually, this is after you die or go into permanent residential care.
The second type of equity release is a home reversion scheme, these are less popular but still a common choice for those looking to release funds from their home. Here is how a home reversion scheme works:
- When you opt for a home reversion scheme, you are selling part or all of your home to a home reversion provider. You must be a UK homeowner and over the age of 65 to be eligible for home reversion.
- You can sell a percentage or all of your home while continuing to live there rent-free. You will need to maintain and insure the property until it is sold.
- The equity can either be released as a tax-free lump sum or as regular income.
- The price that your property will be bought for in a home reversion scheme will be below market value.
- When your home is sold, usually after your death or when you move into permanent residential care, the proceeds of the sale will be split accordingly between the equity release provider and yourself or your family.
Remember that the interest accrued on a lifetime mortgage can add up very quickly and can significantly increase the amount you owe. This can leave your family in a difficult position after you’re gone if the amount that needs to be repaid has increased significantly compared with the value of your property.
Who can choose an equity release plan?
Equity release can be done as a single homeowner or jointly if you own your home together. For a lifetime mortgage, you will both need to be over the age of 55 and for a home reversion scheme you will need to be over the age of 65. You must own your home in the UK, and it must be your main place of residence.
The property you are releasing equity from must be in a reasonable condition and be worth over a specific value. Different equity release providers may have different criteria, and some may have restrictions on the types of property that are accepted.
If you already have a mortgage or other secured loan against your property, then you could still qualify for equity release. However, this depends on the value of your property and the amount outstanding on the existing loan or mortgage.
At the time of taking equity release, any outstanding mortgages or loans will need to be cleared. This could be by using some of the funds from the equity release or by other means such as savings.
Equity release might not be the best choice for those with dependents living in the property. If you do have dependents living in the property and want to take equity release, they may need to take separate legal action and sign a waiver to confirm that they understand they have no right to reside in the property in the event of your death or if you are moved to permanent residential care.
Be sure to find out the exact criteria for equity release from the various providers you are considering to make sure you and your property are eligible for either a lifetime mortgage or home reversion scheme.
How much does it all cost?
Equity release is not a cheap option, and you will be paying for the benefit of releasing funds from your home while still living in it for the remainder of your life. A lifetime mortgage can end up costing over three times what you borrow over 20 years, and home reversion schemes can cost more than 70% of your property’s value while releasing just 20% of the funds.
Although most normal mortgage rates have fallen in recent years, and the Bank of England base rate is at an all-time low, rates for lifetime mortgages are still very high. Equity release will always be a more expensive option compared to a conventional mortgage, as they give you the added benefit of remaining in your home until you die or are moved to permanent residential care.
As no monthly repayments are made with equity release, the interest can soon add up to a very high figure, that must all be paid off after you have passed.
With typical interest rates for a lifetime mortgage sitting at just over 5% as of summer 2018, it is easy to end up paying back much more than you initially borrowed.
For example, if you borrow £20,000 at the age of 60 with a 5% interest rate on a £120,000 property, then the amount you owe will double every 15 years. If you live until 75, you will owe £40,000, and if you live until 90, your debt will be £80,000.
In addition to the cost of the interest, you will also have to pay arrangement fees. In most cases, these are between £1,500 and £3,000 depending on the type of equity release being arranged. These costs include various things such as application fees, fees for any legal work, as well as surveyor and valuation fees.
Before going ahead with equity release, speak with an independent mortgage broker or financial advisor for a professional opinion on your situation. They may be able to give you other options and alternatives that you had never thought of. You can find our top choice providers here on Lending Expert.
Advantages of equity release
Equity release comes with a number of key advantages that can benefit your retirement and improve your life in later years. Deciding whether to take out equity release on your home is a big decision, and all aspects of it should be properly considered. The advantages of equity release are:
- You can continue living in your home when you choose an equity release scheme. Many people use it as an alternative to downsizing to a more affordable home, to avoid the hassle of selling, buying a new home and moving. With equity release, you can stay in your existing home for the rest of your life while also giving yourself some extra income during your retirement.
- Monthly outgoings will stay with same as you don’t need to repay anything on equity release until after you pass away or are moved to permanent residential care. Until this point, equity release will not cost you anything other than set up costs and costs for any financial advice.
- You can spend the money however you want with equity release schemes. The money released is yours to spend as you please. You can use it to cover unexpected expenses, your dream holiday or just to boost your pension pot.
- Take money when you need it with equity release schemes that offer a drawdown service. Not all providers offer this, but some will allow you to take the money as and when you need it and interest is only charged on the cash that has been released.
- Provides tax-free cash to support you financially during your retirement. Any equity that is released as either a lump sum or regular payments will not incur any capital gains tax or income tax.
- Maintain an inheritance for your loved ones after you’re gone. Some equity release plans allow you to keep some of your home’s equity aside specifically for inheritance for your family and loved ones.
Equity release can affect the benefits you are entitled to during your retirement as you will have cash in the bank instead of money tied up in property. Be careful to check the impact equity release could have on your current benefits before going ahead.
Disadvantages of equity release
As with any financial product, equity release is not without its downsides. Before deciding if equity release is the right choice for you and your current situation, you should weigh up the cons and the pros to properly understand what you are getting. The disadvantages of equity release are:
- Interest charges can add up to a very high figure. The longer you borrow the money for through an equity release plan, the longer the interest charges will build up for. It is possible that at the end of the equity release scheme, you or your family could end up having to pay back the entire value of your property.
- The inheritance you can leave will be smaller than if you didn’t have any equity release plan. When you take out equity release on your home, it is inevitable that some of the property’s value will have to be used to repay the loan amount when you die or move into care. This leaves your family and loved ones with less inheritance than if you hadn’t taken any equity release.
- You could miss out on property value increases if you have a home reversion equity release plan. As you have sold some or all of your home to the equity release provider, you will not gain anything from property prices increasing on the portion of the house you have sold.
- Expensive costs such as set up fees, administration charges and legal costs soon add up to a hefty sum that will usually be deducted from the final amount of money you receive. This paired with high-interest rates make equity release an expensive option.
What are the alternatives?
The most popular alternatives to ‘equity release’ are to remortgage your home or take out a second mortgage. Both of these options are loans which you need to make payments for each month. To take out additonal borrowing you will also need to meet the lenders affordability requirements such as having a regular income and you will need to have enough equity in your home to secure the loan against. If you’re under 55 and not eligible for a lifetime mortgage then these may be viable alternative options for you.
Most reputable providers will offer a ‘no negative equity guarantee’. This means that what you owe can never exceed the total value of your property. It is essential to look out for this when choosing a provider, as without it your family could end up owing more than they can afford to pay back after your death. If you would like to get an idea of how much you may be eligable for you can use our free equity release calculator here on the website.