If your parents own their own home, then equity release can be a means to realise capital without having to move house. Equity release provides either a tax-free cash lump sum or the ability to draw down smaller amounts of money against the value of the property.
In this guide you can discover everything you need to know about equity release mortgages, including information on eligibility, interest rates, the financial risks, and where to find independent financial advice.
What is Equity Release?
Put simply, equity release is a way of accessing the money that is stored in the value of a person’s property, as a cash sum. The money raised against the value of the property, as well as interest at a pre-agreed rate, is repaid when the property is sold.
If the home is jointly owned, then the property is only sold after the death of both partners. However, if the mortgage is not written in both partner’s names, the bereaved partner may be forced to sell the home and move out.
Consider other options
Before considering equity release, it’s important to look at other options that may carry less risk. One such option that your relative may want to consider is downsizing. By selling their home and purchasing a cheaper one, they can receive a lump sum of money, and avoid paying high amounts of interest. Downsizing can have further advantages for older people, including having a property that is more suitable to their mobility, or can better meet their social needs. We discuss this further in our top tips on downsizing.
The Main Types of Equity Release
There are 2 common types of equity release: lifetime mortgages and home reversion plans. These options differ somewhat in terms of who is eligible, who owns the property, and how much money can be accessed. We will explain the advantages and disadvantages of lifetime mortgages and home reversion plans below.
The most common type of equity release is by taking out a lifetime mortgage. As with a traditional mortgage, a lifetime equity release mortgage is a loan against the value of the property. It could be a single lump sum or smaller sums over a period of time. The older your parent is, and the greater the value of the property, the larger the sum that can be loaned. There is no time limit or end date to the loan. The total sum is only repaid when the property is sold.
There are different ways in which interest is calculated and paid back on lifetime mortgages.
- With roll-up lifetime mortgages (or compound interest) the total amount repaid to the equity release provider when the property is eventually sold is the initial loan amount plus any accumulated interest. Because the interest is calculated and added each year, the amount of interest added will increase year-on-year, even at a fixed interest rate. This is because the interest added will be calculated as a percentage of the the original loan sum plus the added interest of previous years. As you can see below, this means that the interest added each year will be greater than the last. The graphic below shows how interest ‘rolls up’ each on a £10,000 lifetime mortgage loan at a fixed 4.5% interest rate.
Interest added to the loan after year 1 and year 2.
Interest added to the loan after year 9 and year 10.
- A drawdown lifetime mortgage is similar to a roll-up mortgage, except that you do not receive the money released from the property in one lump sum. According to what you need, some of the money will remain in a reserve account, from which it can be drawn down. With a drawdown lifetime mortgage, interest only accrues on the money that you have released from this account, meaning you are able to reduce the interest charge by keeping money in the reserve account.
- With an interest-only lifetime mortgage, you can choose to pay back a fixed amount of the loan’s interest on a monthly basis. This means that the interest does not increase as much annually as with a roll-up lifetime mortgage. Any interest that is not paid back will begin to ‘roll-up’, as with a roll-up interest plan.
Advantages of Lifetime Mortgages
- A lifetime mortgage means your relative can access the money in their property in a tax-free lump sum, or in regular smaller payments. This can provide additional funds throughout retirement, as opposed to leaving the money locked in the home for future beneficiaries, or to be spent on care costs later down the line.
- Your relative retains ownership of their home. Unlike home reversion plans, your relative will maintain sole ownership of the property, meaning that they, or you, can benefit from any future increase in the value of the property.
- Your relative can transfer the lifetime mortgage plan to another property if their lifetime mortgage provider feels that the new property’s value is secure enough.
Drawbacks of Lifetime Mortgages
- Taking out a lifetime mortgage will reduce the value of your relative’s overall estate, as the money raised from the sale of the property will go towards paying off the loan. This will mean that the amount that can be left to the people named in their Will will be reduced.
- The interest on the loan can increase quickly. To read more, look at our section on the cost of equity release.
- The increased cash accumulated from the lifetime mortgage may affect your relative’s ability to claim some means-tested benefits. This might mean that your relative ends up paying more towards their care.
- Many providers operate a substantial Early Repayment Charge so your relative may not be able to pay off the loan early if they receive an unexpected windfall and want to use it in this way.
Home Reversion Plans
With home reversion plans, a proportion of the value of the property is sold to a home reversion company to provide a tax-free cash lump sum (or sell a percentage first then draw down more by selling more percentages over time). The amount owed is not repayable until the property is sold. So – when the home is eventually sold, your parents or their beneficiaries will only receive the proceeds from the percentage of the house that they still own.
Advantages of Home Reversion Plans
- As with Lifetime Mortgages, Home Reversion Plans allow your relative to access the money in their property in a tax-free lump sum, or in regular smaller payments. This can provide additional funds throughout retirement, as opposed to leaving the money locked in the home for future beneficiaries, or to be spent on care costs later down the line.
- Home reversion plans tend to be able to allow for larger sums of money to be released than from lifetime mortgages.
- Depending on how much of the property your relative retains ownership over, they may be able to benefit from future increases in the value of the property. For example, if they retained 50%, they can reclaim 50% of the sale.
- It is possible to transfer the scheme to a new property, if your relative later decides to move house. This will be dependent on the new property meeting the criteria set by the home reversion plan provider.
Drawbacks of Home Reversion Plans
- Using a Home Reversion Plan will reduce the value of your relative’s estate, as the money raised from the sale of the property will go towards paying off the loan. This will mean that there will be less funds available after their death to distribute.
- The increase in income generated by the Home Reversion Plan may affect the ability to claim some means-tested benefits. This might mean that your relative has to pay more for homecare than may currently be provided by the council.
- The reversion company owns some (or all) of your relative’s property, meaning that they will benefit less from any increase in the value of the property when it is sold.
- Usually, the home reversion scheme provider will pay less than the current market value of the property because they are accounting for the rent-free time your relative will live in the property.
- Following on from the previous point, if your relative dies soon after taking out the home reversion plan then they will effectively have sold their home for significantly less than its market value.
Equity Release Companies
There are a number of companies that provide equity release schemes, including both lifetime mortgages and home reversion plans. If your relative is looking for equity release, they should choose a provider that is registered with the Equity Release Council – this is the industry body who aim to protect the interests of consumers, and providers registered with them are required to meet certain standards.
Equity release providers registered with the Equity Release Council have to offer a No Negative Equity guarantee. This will guarantee that the total sum payable (including interest) will not exceed the final sale price of the property. This means that no debt will be passed on to your family once the property is sold, as long as the property is sold for ‘the best price reasonably obtainable’.
Below we have listed some of the most well-known equity release companies that operate in the UK.
Aviva offer lifetime mortgages for over 55s. They use fixed interest rates that won’t increase, and which are tailored to each applicant’s specific circumstances. People can choose a lump sum, or smaller sums over time.
LV offer two types of lifetime mortgages, both with fixed interest rates. The first type is their ‘lump sum plus’ life mortgage for people looking to release a large sum of money immediately. The other type is their flexible lifetime mortgage, for those who want to borrow some now, and some later down the line.
Scottish Widows’ equity release scheme allows people to access a lump sum, with the option of further amounts down the line. They have fixed interest rates, and there are no early repayment charges.
SunLife offer both lifetime mortgages and home reversion equity release options. With their lifetime mortgages, you have the option of a roll-up lifetime mortgage, a drawdown lifetime mortgage, or an interest-only lifetime mortgage.
Who is Eligible for Equity Release?
Different equity release options have different minimum age requirements. To take out a lifetime mortgage, you must be at least 55 years old. For home reversion plans, most providers will have a minimum age for equity release of 60. Another important criterion in order to be eligible for equity release is that your relative must own outright the amount of the home that they are looking to release the equity from. For example, if they own a £300,000 house, and have an outstanding mortgage of £50,000, they have £250,000 in equity.
Most providers have a minimum home value that they are prepared to allow people to remortgage to equity release, which tends to be £70,000.
Credit history tends not to be particularly important to equity release providers, as you usually do not pay them back in monthly instalments. Nonetheless, they may wish to find out more about your credit history before you take out equity release with them.
How Much Does Equity Release Cost?
The primary cost to consider when thinking about equity release is the interest rate, as this determines the overall amount that will need to be paid back to the lender.
There are fees to be paid to financial advisors, solicitors and for application fees. You can read more about the breakdown of costs involved in equity release on the Equity Release Council’s website.
Equity Release Interest Rates
Equity release interest rates are the primary cost to consider when thinking about equity release, as this determines the overall amount that will need to be paid back to the lender. A typical equity release interest rate for a lifetime mortgage scheme is between 3% and 5%.
As an example, if you borrow £25,000 aged 60 at 4.5% interest rate on a £150,000 home as part of a roll-up lifetime mortgage, then in 15 years time you will owe £48,382. In 30 years, you would owe over £90,000. As you can see below, the interest accrued from an equity release mortgage can increase very quickly.
If you opt for equity release from an Equity Release Council member, then the amount owed will not end up exceeding the total sale price of the property after death.
Another key equity release cost is that of a financial advisor, who will help your relative through the equity release process. Receiving the support of a financial advisor is important, but can also be costly. Some financial advisers request a percentage fee of the released sum of money (normally around 2%), and others demand a flat fee. For this reason, you should consider the size of the sum released when deciding what financial advisor service to use.
Equity Release Solicitor
The Equity Release Council recommends that a solicitor is involved in brokering a deal between your relative and an equity release provider. The solicitor can provide equity release advice and ensure that your relative fully understands the small print and risks of the contract that they are signing. This can help to avoid any problems later down the line. Solicitors fees can vary significantly, depending on if they are an equity release expert or not. If they are an equity release expert, the fees can be expected to cost in the region of £1000 for their services.
Equity Release Application Fees
Some equity release providers also require an application fee to cover their own legal costs and the set-up of the deal. This can cost in the region of £500.
It’s Vital To Get Independent Equity Release Advice
A financial adviser who is authorised and regulated by the Financial Conduct Authority is your best source of independent advice about equity release. There are 2 specialist accreditations that advisers may hold that demonstrate their knowledge and experience of dealing with equity release and other later life issues. These are:
These accreditations show not just their specialist knowledge in providing equity release advice, but they also evidence that the adviser understands the need to safeguard vulnerable people.
The Financial Conduct Authority also suggests that taking independent equity release advice is a good means of protection: if your relative does not take independent financial advice and ends up choosing an unsuitable equity release plan, then they will have fewer grounds for making a complaint.