Equity release: what it is, how it works, costs and more
Equity release is growing in popularity as more people seek to release cash from their home. We reveal how equity release works, when it can be useful and what to watch out for.
What is equity release?
Equity release schemes allow borrowers over the age of 55 to tap into some of the equity they have built up in their home, even if you haven’t fully paid off your mortgage.
You don’t necessarily have to release the money as a lump sum as you can also take it in several smaller amounts, through a drawdown facility.
You won’t be able to release the full value of the equity you’ve built up, as equity release providers impose more restrictive loan-to-values (LTV) on the schemes.
According to Key Equity Release, a total of £884 million was released via equity release schemes in the third quarter of 2020, with the average amount released standing at £82,827.
How do lifetime mortgages work?
There are two main equity release products: a lifetime mortgage or home reversion.
Most people use a lifetime mortgage. As the name suggests, this is a kind of mortgage, where you retain ownership of the property and merely borrow against its value.
You may be able to ‘ring fence’ some of the value of your property to leave to your family when you pass away.
There are a few options when it comes to paying for the loan – you can either choose to make repayments, which might be based on your income or let the interest roll up.
If you choose the latter, you pay back the loan and any interest when you pass away or when you move into long-term care, although this does mean debt can increase quickly over time.
Any remaining funds (if any) after the loan has been paid off is given to your beneficiaries.
How does home reversion work?
Home reversion works differently as you sell part or all of your home in return for a lump sum or regular payments.
While you can continue living in your house until you die rent-free, you need to insure and maintain the property.
Similar to a lifetime mortgage, you can ring-fence a percentage of your property for inheritance proposes.
If the value of your property changes, this doesn’t affect the percentage you retain (unless you release more money).
When the plan ends, the house is sold, and the proceeds are shared to everyone who owns a proportion of the property.
It’s worth pointing out that home reversion plans are no longer commonly sold on the market. The uptake of this type of plan has been under 1% at least since 2015, according to Key’s Market Monitor.
How much can I borrow through an equity release plan?
With a lifetime mortgage, it’s important to stress you have the right to live in your home for as long as you live, as long as it’s your main residence and you don’t break the T&Cs of your contract.
You can move to another property, but this needs to be approved by the product provider as continuing security for the loan.
It’s vital to flag that you usually can’t take out a lifetime mortgage until you turn 55 and there’s a maximum amount you can borrow, which tends to be up to 60% of the value of your property.
There are a few factors that can impact how much cash can be released, which includes your age and the value of your property.
In addition, some providers allow you to release more money if you have some form of medical condition.
What will an equity release plan cost me?
As for interest rates, these must either be fixed or capped to an upper limit for the life of the loan.
According to Key, most borrowers have secured a fixed annual interest rate of 3.92% or lower, which gives you a good ballpark of what to expect.
On top of this, lifetime mortgage products have a ‘no negative equity guarantee.’
This means that you won’t have to pay back more than the value of your home – even if the loan has become larger than the property value.
Alongside interest, you also need to think about fees. You could end up paying between £1,500 and £3,000 in fees for a lifetime mortgage.
It can cost around £500 for a lender fee, while the solicitors fee will set you back £900 on average.
There’s also a funds transfer fee ‒ usually of around £30 ‒ while you’ll also need to pay an adviser for their guidance – this is a regulatory requirement.
On top of this, you could be hit with an early repayment charge (ERC) if you pay off your loan early.
While you can benefit from access to tax-free cash via equity release, you should be aware that any means-tested benefits you have could be impacted.
Income-related Employment and Support Allowance
The costs of a lifetime mortgage can vary hugely depending on your circumstances, but we can take an example to give you an indication of how the costs can add up.
We’ll look at a scenario involving a couple, both aged 65, who own a property worth £375,000 and want to withdraw £90,298 for a comfortable retirement.
According to Key, the majority of its customers choose a drawdown equity release product, so what the couple could do is release £50,298 and then release four separate withdrawals of £10,000.
The couple, who secure an interest rate of 2.78%, decide to withdraw those £10,000 sums after three, five, eight and 10 years.
After five years, they would owe £81,057. Once 10 years had passed this would have grown to £114,742, while after 20 years the debt would have risen to £151,089.
However, some lifetime mortgages allow you to make voluntary interest payments each month, in order to reduce the eventual size of your debt.
According to Key, if they did this the owed balance would be £70,298 after five years, increasing to £90,298 at 10 years and remaining at this level at 20 years (as the interest is being paid off).
Below is a graph showing the difference in the amount owed in this scenario, based on whether the interest is allowed to roll up or not.
* Based on monthly interest payments rising to £162.86 a month after paying £116.52 for the first five years.
** Based on monthly interest payments of £209.19
*** Based on monthly interest payments of £209.19
Why is equity release growing in popularity?
Equity release has become more popular over the last few years, with the number of new plans more than doubling from 21,350 in 2015 to 45,598 by 2019, according to the most recent figures from Key’s Market Monitor.
“There are more over-55-year olds in the UK than ever before, but there are also more people entering retirement with lower pensions than expected but with bigger aspirations and more unsecured as well as secured debts,” said Hale.
“Then there is the issue of the ‘squeezed middle’ with people looking to help younger family members onto the property ladder while potentially supporting their older parents.”
Equity release plans have also proven popular with borrowers who are approaching the end of an interest-only mortgage, but who have no real plan in place for how to clear the capital they owe without selling their home.
There are predictions within the industry that this popularity is likely to increase next year, as awareness of equity release improves, coupled with stretched finances post-Covid-19.
To meet the growing demand, the number of equity release products available has risen sharply over the last few years. Back at the start of 2018 there were just 86 plans available, but there are now 525.
Who is equity release suitable for?
Whether or not equity release is right for you depends on your personal circumstances.
“For older homeowners, particularly those who are asset rich but cash poor, property wealth can serve a range of purposes, including supplementing retirement incomes, paying for home care, consolidating existing debt, supporting family members and meeting lifestyle costs,” said Jim Boyd, chief executive officer of the Equity Release Council.
Equity release can also be useful for Inheritance Tax (IHT) purposes. IHT is paid after someone passes away and is based on the value of their estate.
If the value of the estate exceeds the £325,000 threshold (and you don’t leave anything above this amount to your spouse, civil partner or a charity), you will have to pay IHT.
A married couple or civil partnership can combine their allowances to avoid paying IHT on estates worth up to £650,000.
“Technically you can use equity release to cut an IHT bill, because you could free up cash, and give it away, and then as long as you live for seven years, it’s out of your estate for IHT purposes,” commented Sarah Coles, personal finance analyst at Hargreaves Lansdown.
“But in reality, if you did this specifically to avoid IHT it would fall foul of anti-avoidance rules, so it would be counted as part of your estate anyway.
“You could do it for other reasons and enjoy an IHT benefit – but it can’t be done with tax in mind.”
It’s worth flagging that any money you get from a lifetime mortgage is not defined as income, so you pay no tax – but you do pay interest.
“It’s worth doing the maths to see how much it could end up costing you before you go anywhere near equity release,” warned Coles.
It’s also vital that you check that your adviser searches the whole of the market to find the right deal for you and that they are on the Financial Conduct Authority (FCA) register.
They should be a member of the Equity Release Council, so you should able to find them on the directory.
“Customers of Equity Release Council member firms receive three levels of protection, encompassing: a structured financial advice process; independent face-to-face legal advice; and clear product safeguards,” commented Boyd.
“For these reasons, we recommend that anyone considering equity release do so through a member of the council.”
Who is equity release not suitable for?
If you’re considering an equity release product, it’s not enough to simply look at how you’ll use that cash – you must consider how it will impact your future, particularly your financial situation.
“You can technically use equity release from the age of 55 but need to be very careful about using it when you’re younger, because the longer you borrow the money for, the more it’ll cost,” warned Coles.
“With a rate of 5%, rolling up the interest will double the debt every 14 years.”
There are alternatives to equity release that might be a better option, such as downsizing or using another form of borrowing.
You could use any untouched pension pots or turn to family for help if equity release is not possible.
But Coles flags if you plan to downsize to release equity, it’s better to do it sooner rather than later.
“The trouble with releasing equity and then downsizing decades later is that the loan needs to be repaid when you sell up – and may mean you can’t afford to buy a smaller property,” said Coles.
If you’re single, it’s also worth thinking about whether you plan to remarry.
“If you take equity release out on your property and in your name then on your death the property will need to be sold and the debt repaid,” commented Coles.
“If you’ve remarried by then, your new spouse could lose their home.”
Also, as we mentioned earlier, using equity release could impact your entitlement to benefits.
Who are the main players?
The largest UK providers of equity release are Aviva, more2life and Legal & General, who between them provide more than a third of the equity release products on the market.
Aviva offers two lifetime mortgage options, which are Lifestyle Lump Sum Max and Lifestyle Flexible.
These products can be used in various ways, including to pay off a mortgage, for home improvements or on holidays.
Lifestyle Lump Sum Max allows you to borrow a one-off cash sum of at least £15,000 although you may be able to borrow more, depending on your age and the current value of your home.
The Lifestyle Flexible option allows you to receive an initial cash sum and set up a reserve so you can draw money from it whenever you want.
So, you only pay interest on the cash you have taken from the lifetime mortgage.
But you need to take out a minimum of £10,000 and place at least £5,000 into your cash reserve.
Aviva said it doesn’t provide an average interest rate, as it depends on a customer’s circumstances.
But they did give some example of rates below:
If a 62-year-old male with a property valued at £215,000 decided to release £32,000 with £15,150 in a reserve using the Lifestyle Flexible option, they would get a non-enhanced interest rate of 3.07% or APR of 3.10%.
If a 76-year-old female decided to release £84,000 from her property worth £200,000 using Lifestyle Lump Sum Max, she would be offered a non-enhanced interest rate of 3.14% or APR of 3.20%.
These scenarios are based on no adviser fee being charged, no cashback or inheritance guarantee taken, and no medical enhancement, while the valuation was paid by the customer.
More2life has several different equity release plans for those aged at least 55 and up to the age of 95 in some cases, but the product features vary.
For example, Flexi Choice plans offer two rates: Annual Equivalent Rate (AER) and Monthly Equivalent Rate (MER), which refers to how the interest is calculated.
Interest rates vary massively on the Flexi Choice plans, partly depending on whether MER or AER is used and whether they are ‘fee’ or ‘fee-free’ as some brokers may not charge an advisor fee.
According to more2life, the Flexi Choice plans offer ‘some of the lowest rates on the market’ so the other products are likely to offer higher interest rates in comparison.
You can choose a one-off lump sum or a smaller amount with the option to drawdown cash in the future. A cash facility can be used to meet your borrowing needs, but the LTV cannot exceed the maximum lending on the plan.
Also, you can repay up to 10% of the total cash advanced every year, but there are fixed ERCs to watch out for.
In some cases, you may be exempt from ERCs. For example, if your husband or wife dies or goes into care, you may be able to repay the loan early without any charges.
There’s also downsizing protection, which allows someone to downsize and repay the equity release plan in full without getting hit with ERCs.
You may also be able to transfer a lifetime mortgage to a new property, but this depends on lending criteria.
Inheritance protection may also be available, which allows you to select a percentage of the property value to protect for inheritance purposes.
Below is a table summarising the key features of the different plans:
*Available with enhanced LTVs for clients with specific health conditions
Legal & General
Legal & General offers three options to release equity from your home to use on whatever you want, whether it’s home improvements or paying off an existing mortgage.
To be eligible for these products, you need to be at least 55 and living (or buying) your own home, with either a small or no mortgage. You may have to pay an arrangement fee of £599 on certain products.
A Flexible Lifetime Mortgage allows you to get a tax-free lump sum of at least £10,000 the first time and then minimum future lump sums of £2,000 each time. The property needs to be worth at least £100,000.
If you take smaller amount of money, a different interest rate may apply to each separate amount.
You don’t need to make any monthly interest payments, but you have the option to make partial repayments to manage the loan amount.
Legal & General also offers the Optional Payment Lifetime Mortgage, allowing you to get a tax-free cash sum or smaller amounts when you need them, as well as make monthly interest payments.
The equity release provider says this product could help those approaching the end of an interest-only mortgage, who need to repay it.
It’s vital to stress that with the Optional Payment Lifetime Mortgage, once you stop interest payments, you cannot restart them.
The final product is the Income Lifetime Mortgage, which provides a regular monthly income over 10, 15, 20 or 25 years with a minimum initial cash sum.
You can release a minimum of £200 a month once you have taken at least £2,500 as an initial cash sum.
But you need to be wary about impact of inflation as it may reduce the value of your income over time.
While you can stop the payments from Legal & General at any time, once you stop them, you cannot restart them.
Once the fixed income period ends, you won’t get any more money, but the interest will continue to roll up until the lifetime mortgage is repaid.
In the next section, we talk to Sandra Eke, 69, about her experience of using equity release.
‘Super quality of life’
Eke used equity release with more2life to access £100,000, which she used to help her daughter rent a property and to pay for an extension to her house.
She also used the money to pay for a holiday for her daughter and her three children, for cruises to Thailand, Singapore and to buy a new car.
“The money has enabled me to have a super quality of life and my four girls were absolutely in agreement as they want me to enjoy my retirement,” said Eke.
“Given the past history of house prices and life expectancy, although nobody can predict how long one lives, there still will be money left for my daughters when l pass away.”
She decided to let the interest roll up as she believes the added value to the house via the refurbishment will offset some of the interest being charged.
Before Eke took out equity release, which took three months to sort out, she did six months of research and got in touch with many equity release providers.
“The adviser [from Key] that visited me was so helpful and informative, l really felt she was looking after my interests,” commented Eke.
“They give you all the advice and calculations to see how much interest you will owe annually so you can see for yourself just how much you are going to pay.”
Eke could have opted for a small mortgage but chose not to due to the repayments.
While she is happy with equity release, she felt she didn’t borrow enough money as you ‘try to borrow the least amount’ – so she had to go through the process again.
She recommends that those considering equity release think carefully about how much to borrow, especially if it’s being used for home improvements as the cost was higher than expected.
“Research the various companies as fees and interest charges and penalties all differ, and would make a big difference to compound interest,” commented Eke.
*This article contains affiliate links, which means we may receive a commission on any sales of products or services we write about. This article was written completely independently.
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