Equity release: how it works, costs, different products and more

Thanks to decades of rising house prices, many nearing or already in retirement are sitting on huge amounts of equity in their homes.

The problem is that having a very valuable house doesn’t make you any better off in retirement in terms of the cash you have available to spend.

If you’re reluctant to move but want to access some of the tax-free wealth you have tied up in bricks and mortar, equity release is something that may be worth considering.

Boom in borrowers – and lenders

Once dismissed by many due to the poor reputation it (rightfully) gained after mis-selling scandals in the 1980s and 90s, equity release is experiencing a resurgence in popularity.

According to the Equity Release Council (ERC), more than £4 billion was handed out to homeowners via equity release last year.

And as more homeowners ponder equity release, lenders have been rushing new products to market.

Figures from equity release referral service Key Partnerships show you can now choose from 314 different plans.

This represents an increase of more than 300% from just 73 plans at the end of 2016, as the table below highlights.

Year	Number of equity release plans	Year-on-year change
End October 2019	314	+95%
Full-year 2018	161	+87%
Full-year 2017	86	+18%
Full-year 2016	73	n/a

Think carefully before you act

However, there's a real danger that people who are tempted by cash in the short term are simply setting themselves up for financial disaster further down the road if they don't fully understand what they've signed up for, as we'll explain a little later.

So, is it right for you? It helps to clarify exactly how equity release works before making any decision.

Can equity release work for people with decent pension savings?

Equity release is when you borrow against the value of your home.

While you do not usually need to make any repayments on the loan, you are able to remain in your home until you die or go into long-term care.

At that point, you will repay the company that loaned you the money or they will claim your home.

There are two main types of equity release plans: lifetime mortgages and home reversion plans (covered in detail in section 7).

Want to know how much tax-free cash you could free up from your home? This equity release calculator from Saga will help.

Lifetime mortgages are the most popular type of equity release plan, accounting for the vast majority of equity release plans taken out.

These are available to those aged 55 and over and are loans secured on your home that you usually do not pay interest on. Instead, the interest is accumulated and added to your loan.

Previously, lifetime mortgages were usually lump sums taken all at once and a significant portion of borrowers still opt for this type of equity release.

Equity release for buy-to-let: is it ever a good idea for landlords?

In recent years, drawdown lifetime mortgages have become more popular with borrowers.

With this type of plan, the provider agrees to a total amount you can borrow, but you can access cash as and when you need it, rather than taking it all at once.

The drawdown option has a big advantage as you only pay interest on funds once you’ve withdrawn them, which could dramatically reduce the sum you end up owing.

As you normally don’t make repayments on the amount you borrow, the sum you owe can escalate far beyond what you originally borrowed, especially if you live for a long time after you’ve taken out the equity release plan.

Interest rates on equity release policies are generally much higher than on traditional residential mortgages, although rates have become more competitive in recent years.

In July this year, research from financial data site Moneyfacts revealed the average rate for equity release mortgages had fallen below 5% for the first time.

The number of products available has also risen to 369 compared with just 51 five years ago.

But even at an interest rate of 5%, the cost of equity release quickly adds up.

For example, if your home is worth £400,000 and you release a fifth (20%) of its value – £80,000 – at an interest rate of 5%, the cost of the lifetime mortgage will increase as follows:

Start	£80,000
One year	£84,000
Three years	£92,610
Five years	£102,102
10 years	£130,312
20 years	£212,264
30 years	£345,755

As you can see, it’s essentially a reverse mortgage that can wipe out the value of your home over time.

The effect of compounding, or interest on interest, could even mean when you leave your home, its value is lower than the amount now owing against it.

If house prices rise, then this shouldn’t be an issue.

But if they don’t, there is the danger of negative equity – when the value of the house is worth less than the outstanding balance of a loan or mortgage.

Many equity release plans now come with a ‘no negative equity guarantee.’

This means even if you do end up in negative equity when you die or move into care, you or your estate will not have to pay any difference to your provider.

Find out how much tax-free cash you could release and how much it will cost with Saga's equity release calculator.

There are also now plans available that allow you to pay off interest or even capital on a regular basis, which can reduce the effect of compounding.

If you’re in a position to make regular payments, perhaps through your pension income, you might be better off exploring the option of a retirement interest-only mortgage.

It’s also worth talking to a mortgage broker as you may find you can even access standard residential mortgages.

Over the past five years, lenders have been steadily increasing the age they will offer standard mortgages to, with some now offering deals that won’t be repaid until borrowers are in their 90s.

Mortgages for older borrowers: who will lend and the risks

Home reversion plans are typically available to those aged 60, or in some cases, at least 65.

It involves selling all or part of your home to a company that allows you to continue living there rent-free until you die or move into care.

Typically, you’ll get an amount much lower than market value for the portion of your home you sell, as the company may have to wait many years to recoup its money.

If you only sell a portion of your home to the company, you or your estate will receive the proceeds of the percentage you still owned at the time you left the property.

Take-up of home reversion plans has become fallen dramatically in recent years, with ERC figures showing these accounted for less than 1% of new plans taken out in the first half of this year.

Find out how much tax-free cash you could release and how much it will cost with Saga's equity release calculator.

The industry's reputation has improved over the last few years, but it's essential that you use a provider that is affiliated with the ERC.

If you want to repay an equity release loan earlier than anticipated, exit fees can be high.

There are also fees to consider when setting up equity release, which usually range between £1,000 and £3,000.

You should carefully consider any bequests you planned to give to family or friends as you are essentially signing all or part of your home away. This means it cannot be passed on as an inheritance.

On the other hand, equity release can also be a tax-efficient estate planning tool in some circumstances.

Another thing to consider is the effect it may have on any benefits you are claiming, as some benefits are means-tested and others are affected by the amount of cash you have in the bank.

If you receive Pension Credit or a reduction in Council Tax, you could find your entitlement changes if you release equity from your home.

If you're interested in finding out how much cash you could free up and what it might cost, take a look at this equity release calculator from Saga.

Remember, there are many providers on the market so be sure to do your research before locking into and deal.

Finally, if you need to free up additional funds but don't want to risk your home, then look at these alternatives to equity release.