What is equity release and how does it work? – Equity release mortgages explained

If you have owned a property for a period of time you will likely have built up a sizeable amount of equity in the property or maybe even own it outright. Equity release schemes allow you to access some of these funds to help you supplement your pension or to meet unexpected expenses in later life.

Equity release is typically available to those aged 55+ and because the loan will generally not need to be repaid in your lifetime, there is no need to worry about making repayments from your retirement income.

How to release equity in your home

Equity release is an expensive lifetime commitment that should not be entered into without thorough research and so independent financial advice is recommended.

There are two types of equity release mortgage available. These include lifetime mortgages and home reversion plans. Both types will reduce your estate.

Lifetime mortgage and how it works

A lifetime mortgage is a loan against your property which is only repaid after you die or move into care. You can continue living in your home for as long as you wish and you will receive a tax free lump sum that you can use however you like. Lifetime mortgages are the most common type of equity release.

If you take out a lifetime mortgage you can borrow a percentage of your home's value and interest is charged on the loan amount. The interest rate will be fixed and will typically be left to roll up, meaning nothing has to be paid back until you die or sell your home. If you allow the interest to roll up then the debt will increase over time reducing the amount of inheritance left for your beneficiaries. However, some lifetime mortgages do now offer the option to pay all or part of the interest charged, rather than be added to the loan. This can be a way to avoid the effects of compound interest and leave more behind for your family and friends.

Home reversion plan and how it works

With a home reversion plan, you sell a percentage or all of your home to a home reversion provider in return for a lump sum or regular payments. You have the right to continue living in the property rent-free until you die, but you have to agree to maintain and insure it.

The amount of the loan will equate to a percentage of the property which will be valued at below the market value. When your property is eventually sold the sale proceeds are shared according to the originally agreed percentage. For example, if you sold 50% of your property to the provider then 50% of the sale price would be payable no matter how large that sum may be. The effect of discounted valuation at the outset together with the increase in property values over time can leave a lump sum payable to the provider (following the sale of the property) many times higher than the original loan.

For example, if you were offered a loan of 20% of your property with a valuation of £250,000, in real terms, you would expect around £50,000. But home reversion plans typically offer you a figure that is around 20% to 60% of the value of the part of the property you're selling. So you could get as little as £10,000 for a share of your property that is ordinarily worth £50,000.

Over time your property value should increase and if it was eventually sold for £350,000 then the amount to be repaid would be £70,000 (20% of £350,000) a massive increase on the original loan amount of £10,000.

That said, if you have no family or friends to leave your property to and you have no other realistic ways of getting cash, a home reversion plan could work well in some circumstances.

Who is eligible for an equity release mortgage?

You need to own your own property either mortgage-free or with a small mortgage. For a lifetime mortgage, you need to be at least 55 years of age and for a home reversion loan typically at least 60 years of age. However, the exact requirements vary depending on your provider of choice. Also, typically the best rates are reserved for older customers.

How much does an equity release mortgage cost?

Lifetime mortgage rates currently stand at around 6%. Over the lifetime of the loan, this can add up to a substantial sum which would need to be repaid out of the sale of the home. For example, if you secured a £50,000 equity release loan at around 6%, the total you owe would nearly double in 10 years. Within 20 years, you could owe more than £160,000, of which around £110,000 would be interest that has compounded over time.

In addition to the interest rate calculation above, there will be fees to pay on top and these include:

• Arrangement fee - This is usually paid at the time of application.
• Valuation fee - The provider will need to ascertain the value of your property and you may need to pay for this service.
• Solicitor fees - These cover all the legal aspects of arranging the scheme.
• Mortgage intermediary/ 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.

With a home reversion plan, there is no mortgage involved so no interest is charged. However, many of the above fees will still be payable and you will receive less than the true value of your home at the outset.

How much money can you release with an equity release mortgage?

The amount you can release with an equity release mortgage will vary and is based on your individual circumstances. Typically, however, the older you are when you opt to release equity, the more you can release.

With a lifetime mortgage, for example, you can usually release between 20% and 60% of your property's value in the form of a loan. So if your home is worth £250,000, you would be able to release between £50,000 and £150,000 as tax-free cash. Interest would apply on the loan which means that a £150,000 loan at 6% interest in 20 years would result in debt amounting to more than £480,000. Unless the home is sold for more than that, the full amount could go to the lender leaving nothing behind for your family.

Similarly, with a home reversion mortgage, you will usually be offered between 20% and 60% of the true value of the portion of your home you're willing to sell. So, let's say you want to sell 50% of your property which is valued at £250,000. Typically, this would be worth around £125,000. With a home reversion plan, you would be offered between 20% to 60% of the value of the property which means you could end up with a figure between £25,000 and £75,000.

There is no interest due on this loan, but your family would need to pay the provider their 50% stake when they sell the property. So, if they sell it for £500,000, they would need to give the provider around £250,000 meaning they would have made money off buying the property at a discount as well as the appreciation over time.

Remember: The amount you release using an equity release mortgage would need to be used to pay off any existing mortgage that is secured against your home

Lifetime mortgage pros and cons

Below, we outline some of the pros and cons of lifetime mortgages.

Pros of a lifetime mortgage

• Can borrow against your property but remain living there
• Not required to make any repayments of capital or interest
• Still benefit from property value increases
• In most cases, you can move house and transfer your equity release mortgage to another property
• Might be able to access additional funds as your property increases in value

Cons of a lifetime mortgage

• If no repayments are made then the outstanding loan increases substantially over time due to compound interest
• Will reduce the equity left in your property if you want to move or release further equity later in life
• Any money received may affect your entitlement to state benefits
• Will reduce the amount available to your beneficiaries in death

Home reversion plan pros and cons

Below, we outline some of the pros and cons of a home reversion plan.

Pros of a home reversion plan

• Can borrow against your property but remain living there
• Debt will build up over time
• No monthly repayments
• Might be able to access additional funds as your property increases in value

Cons of a home reversion plan

• You will get less than the market value for the percentage of your property sold to the home reversion provider
• You won't own (all of) your property anymore
• Some schemes can take a long time to arrange and some providers are selective on the types and conditions of the properties on which they will provide a loan
• Relatives will not be able to retain the property after the death of the owner

Is equity release a good idea? Things to consider before releasing equity in your home

• Equity release can be more expensive than obtaining a regular mortgage or loan
• Interest is charged as soon as you draw down money, so don't borrow more than you need and consider a drawdown arrangement where you can draw money as you need it
• Lifetime mortgages have no fixed term or date by which the loan must be repaid
• Home reversion plans will usually not give you anything near the true market value of your home when compared to selling your property on the open market
• If you release equity from your home, you might not be able to rely on your property to raise funds you may need later in your retirement. For instance, if you need to pay for long-term care
• Although you can move home and take your lifetime mortgage with you, you might not have enough equity in your home to downsize later on
• The money you receive from equity release might affect your entitlement to state benefits.
• You will have to pay arrangement fees which you will need to budget for
• If you’ve taken out an interest roll-up plan, there will be less for you to pass on to your family as an inheritance
• These schemes can be complicated to unravel if you change your mind
• There might be early repayment charges if you change your mind, which could be expensive, although they are not applicable if you die or move into long-term care
• Make sure the equity mortgage provider you use is a member of the Equity Release Council. This trade body's members must promise a 'no negative equity' guarantee, so your estate will never owe more than your home is worth

Should I seek financial advice if considering an equity release mortgage?

If you are considering an equity release mortgage then you should first seek independent financial advice. A financial advisor will give you advice on your own personal circumstances so you can make an informed decision before you proceed. Booking a free, no-obligation consultation with an independent FCA-regulated financial advisor is a great first step if you're considering going down this route.

What are the alternatives to an equity release mortgage?

There are some options that you should consider before you consider an equity release mortgage.

• Downsizing - can you move to a smaller property and release some money to supplement your pension in later life
• Unsecured loan - if the sum you want to borrow is small and you can meet repayments out of retirement income, it might be cheaper to take out an unsecured personal loan
• Extending your mortgage - If you haven't paid off an existing mortgage by the time you retire, it may be possible for your current lender to extend the term to allow you to do so
• Retirement mortgage - increasing numbers of lenders are offering retirement interest-only mortgages, where you can pay the interest but not the capital each month. Some lenders don't have a maximum age at which you can apply, making them an interesting alternative to equity release
• Family members - depending on their own personal circumstances, family members may be prepared to lend you an amount of money to supplement your income particularly if they will eventually benefit from your estate.

If you're interested in other options, check out our article on alternatives to equity release to help you decide if there may be a different way to meet your goals.