While using these products can avoid the need to sell your home, they can also come with risks – including rising costs and erosion of estate value. Charles Barrow explores the pros, cons and possible alternatives to equity release mortgages.
What is an equity release mortgage?
Equity release is a financial product designed to help homeowners aged 55 and over access the equity (the value of the home minus any outstanding mortgage) in their property. While they offer a way to supplement retirement income or fund home improvements, equity release mortgages come with important considerations that potential borrowers should fully understand before committing.
There are typically two types of equity release products:
- lifetime mortgages or
- home reversion plans.
The most common type of equity release product is the lifetime mortgage, which is essentially a loan secured against the property. The homeowner borrows a lump sum or chooses a drawdown facility where they can release funds as needed. The loan, plus interest, is typically repaid when the homeowner passes away or moves into long-term care. The main appeal of equity release is that borrowers are not required to make monthly repayments, as the loan is repaid from the proceeds of the sale of the property when the homeowner dies or leaves the home permanently.
Generally, the older the homeowner, the more equity they can release. This is because older individuals are less likely to live for an extended period, and the lender is taking on less risk.
The other type of mortgage is the home reversion plan, whereby the homeowner sells a percentage (or all) of their home to a reversion provider in exchange for a lump sum or regular payments. The homeowner can continue living in the property, but the reversion provider owns the share of the home sold. When the homeowner passes away or moves into a care facility, the reversion company sells the property and receives the agreed-upon percentage of the sale price.
How does an equity release mortgage work?
Equity release mortgages are based on the value of the homeowner’s property, the homeowner’s age, and sometimes their health. Generally, the older the homeowner, the more equity they can release. This is because older individuals are less likely to live for an extended period, and the lender is taking on less risk.
The equity release company will first conduct an independent valuation of the property. The homeowner can then choose how they wish to access the funds, either as a lump sum or through a drawdown plan that allows them to access smaller amounts as needed.
Equity release requires thorough consideration of the long-term impact on the homeowner's financial legacy.
Interest is charged on the loan, but it’s not paid monthly. Instead, the interest is compounded and added to the total loan amount. This means that over time, the loan can grow significantly. The debt is repaid when the homeowner passes away or moves into a care home. If the value of the property at that point exceeds the loan amount, any remaining equity is passed on to the homeowner’s heirs. If the property sells for less than the loan, most equity release plans offer a ‘no negative equity guarantee’, ensuring that the homeowner or their estate will not owe more than the property is worth.
Advantages of equity release mortgages
Access to tax-free cash: One of the biggest draws of equity release is that homeowners can access significant sums of tax-free cash that can be used for anything, from enhancing their quality of life in retirement to funding home improvements or medical expenses.
No monthly repayments required: Unlike traditional mortgages, repayment is typically deferred until death or entry into long term care. This is a significant advantage for retirees who may have a limited income and do not want the burden of regular payments.
Remain in your home: The homeowner retains full ownership of the property and can continue living there for as long as they wish, with no threat of eviction.
Flexible repayment options: Many equity release schemes allow for flexible repayment terms. For example, some policies allow for partial repayments, which can reduce the amount of interest accrued over time.
Disadvantages of equity release mortgages
Compounding interest accumulation: While homeowners can live in their property for as long as they wish, the amount of equity remaining in the home for inheritance purposes will be reduced as the loan and interest compound over time.
High initial costs: There are fees associated with setting up an equity release mortgage, including valuations, legal fees and arrangement fees. These costs can be substantial, depending on the terms and lender.
Potential impact on benefits: Equity release can affect eligibility for means-tested benefits, such as pension credit or local authority care funding. If the cash released is not used wisely, it could reduce the financial assistance the homeowner is entitled to.
Not suitable for everyone: Equity release is generally not a suitable option for younger homeowners, or for those who plan to move in the near future. The more time the homeowner spends in the property, the more likely the loan balance will grow significantly.
Reduced flexibility: Early repayment can incur significant penalties, and moving home may be complicated.
Interest rate risk: Rising interest rates can increase the cost of borrowing over time.
Is equity release right for you?
Equity release mortgages are not suitable for everyone. It is essential to ensure that equity release is the right solution for the homeowner's circumstances. There are alternatives to consider, as detailed on the next page.
Equity release: a last resort
Equity release can provide a source of tax-free cash for homeowners in later life, but it is not a decision to be taken lightly. The long-term financial implications—particularly the erosion of estate value—mean it should typically be considered only after all other options have been explored and exhausted. If equity release is still on the table after assessing alternatives, it is vital to proceed with full understanding of the risks, costs, and irreversible nature of the product.
The information provided in this article is of a general nature and is not a substitute for specific advice with regard to your own circumstances. You are recommended to obtain specific advice from a qualified professional before you take any action or refrain from action.
