If you are in, or close to, retirement then you may be worried about a drop in income in your golden years. Many people in this situation have a large amount of equity built up in their property and being able to unlock this money could produce a much needed boost to their income.
Equity release is the term used to describe the type of arrangement used to unlock the equity in a property which in turn can produce an income. Such schemes are nothing new and have been available since 1965.
How does equity release work?
There are two main types of equity release scheme - lifetime mortgage and home reversion schemes
- Lifetime mortgage
With a lifetime mortgage you borrow a proportion of your home's value and interest is charged on this amount. The loan and accrued interest are not usually paid back until death or the sale of the property. It is also possible to get lifetime mortgages where the maximum amount that can be borrowed is agreed up front but you can then choose to drawdown on this amount whenever you wish, only paying interest on the amount borrowed to date.
- Home reversion scheme
With a home reversion scheme, you sell a share of your property to the provider for less than the market value. You have the right to stay in your home for the rest of your life. On death, or sale of the property, the provider will receive the same percentage share of the property sale proceeds, which may be a considerably larger sum than the original figure.
What are the advantages and disadvantages of each equity release scheme?
- Lifetime mortgage
No payments required of either capital or interest during your lifetime
You retain legal ownership of the property and the right to remain living in it during your lifetime
Since you own the property you should still benefit from an increase in the property value but see the disadvantage below.
As nobody knows how long they will live you cannot be sure how much the loan and accrued interest will be on your death. Whilst you may have initially taken out a loan for a low percentage of your property value this may grow substantially if you live to ripe old age. Interest rates on this type of loan are rarely competitive which will compound this problem.
- Home reversion scheme
No payments required during your lifetime, all money is recovered by the provider on your death.
Providing you keep a share of your property you will still benefit from any rise in the value of this percentage of your property in the future.
If you are in poor health then the payment may be increased
In general, larger payments can be achieved through this type of scheme than under lifetime mortgages. This may particularly suit people with an outstanding mortgage that needs to paid off.
You only receive a part share of the actual property value when you sell it to the provider. The difference is retained by the provider in exchange for the right for you to live in your property for the rest of your life.
According to Which? you can take out some lifetime mortgages from the age of 55, but home reversions are available only to people aged 65 or older.
If you die shortly after arranging the scheme then your estate value will suffer as you will have sold your property cheaply, although some policies have an 'early vacancy guarantee’, which means your estate is guaranteed to get a certain percentage of the property’s value back if you die or move into long-term care within a set period of time.
What are the costs involved in equity release schemes?
Arrangement fee - This is usually paid at the time of application and will typically be £300-£600
Valuation fee - The provider will need to ascertain the value of your property and this fee will typically be £200-£400
Solicitor fees - These cover all the legal aspects of arranging the scheme and could typically be £300-£600
Mortgage intermediary's / Financial Adviser - If you are using the services of an intermediary then they may well charge a fee for their services which must be disclosed at the outset.
Are there any tax implications for equity release schemes
The lump sum generated from equity release schemes is tax free, however, any growth or income generated from investing any proceeds may be liable to income tax or CGT.
What else should I bear in mind?
When entering into an equity release scheme you are signing up to a lifelong financial commitment. Accordingly your options are limited if you change you mind or want to move house.
Bear in mind that when you release equity you have a capital sum which may affect your entitlement to some means-tested benefits. Make sure you check the situation out beforehand.
Which? suggest that if you take out a lifetime mortgage that you should always see if you can get a better deal once the early repayment charge period has ended.
Equity release schemes can provide a much needed injection of money to those on a low pension income, however this will come at the cost of reducing the value of your estate. Equity release might not be the best option for you so I would suggest investigating other avenues of raising money before you enter into a scheme.
Perhaps the best option for releasing equity from your property is to downsize to a smaller home. Alternatively, it may be more beneficial to draw income from a pension, or other investments.
As long as you are aware of the risks and implications of equity release then some people have found it a useful facility. But seek independent financial advice before doing anything.