How does equity release work

How does equity release work

This page was last updated on 1 October 2020

How does equity release work

If you are hoping to get some extra cash in retirement, you might be considering equity release.

This guide aims to answer some of the most commonly asked questions regarding equity release schemes. It gives you details about:

  • what equity release is
  • how does equity release work
  • who might release equity
  • the alternatives to equity release

The article guides you through this key information and gives you specialist advice on equity release so that you can decide what’s right for you.

Topics that you will find covered on this page

What is equity release?

Equity release products allow you to unlock cash tied up in the value of your property.

The way the release of equity will work depends on which type of product you select. There are two main types of equity release: lifetime mortgages, and home reversion plans.

Lifetime mortgages

A life mortgage is the most popular form of equity release in 2020.

This equity release scheme is where you take out a loan secured against the value of your main residence. You don’t need to sell your house.

Instead, you simply receive a one-off lump sum of tax-free money from the mortgage provider. If you choose a mortgage with a drawdown facility, you will also later be able to withdraw more cash from a special reserve bank account as income.

Interest will then roll up every month on the amount that you borrow. Interest rates are fixed for life. You can read about the average 2020 interest rates here.

You do not need to make any interest repayments, but you can choose to do so with a flexible plan (see below).

Instead, the loan and interest will be paid off at the end of the mortgage term. This is either after your death, or once you move into long-term care.

At that point, the mortgage provider will sell your property and use the proceeds to write off your debt.

Because these plans are authorised and regulated by the Financial Conduct Authority and Equity Release Council, you will never owe more than the total value of your property. This is called a no-negative equity guarantee.

Home reversion plans

Home reversion is when you sell a share of your property to an insurance company in exchange for tax-free money in retirement. You can choose to get either a lump sum, or a regular income.

Even though you have sold part of your property and are no longer the sole homeowner, you will not need to make any rent payments to the new landlord. A Lifetime Lease means that you are guaranteed to be able to continue living in your house rent free for the remainder of your life.

There is no interest to be paid with this equity release plan, as the money is not loaned to you. Instead, you are selling part or all of your property to the insurance provider in exchange for cash.

For more advice on which service is right for you, contact an independent adviser. They can guide you through the options and the details of the plans and features that each provider has on offer, saving you from unnecessary stress and worry.

Can you get equity release if you are under 55?

No. Equity release providers have strict lending criteria that you must meet in order to take out a product.

The lending criteria vary slightly depending on which equity release schemes you are considering.

Lifetime mortgage eligibility requirements

  • You must be a minimum of 55 years old. If you are making a joint application, both homeowners must be age 55 or over. There is normally no maximum age for a lifetime mortgage.
  • You must own a UK property in good condition valued at £70,000 or more. Sheltered housing, properties above commercial premises, or listed buildings may not be accepted by the provider because they will be harder to sell at the end of the mortgage term.
  • You must not have any other debts or mortgages currently secured against your home. If you have outstanding debts of this type, you need to use the money you borrow to pay off those debts. This is one of the terms of the contract that you will sign.
  • You must speak to an independent, professional financial adviser before making any agreements with a mortgage provider. This is a legal requirement and can be a very helpful way to reduce worry about any future implications of equity release.

Home reversion plan lending criteria

  • Legally, you must be at least age 60 or older to take out home reversion plans. In joint applications, both homeowners must be aged 60 or over. However, it is very common for home reversion plan providers to require homeowners to be 65 or older.
  • Your property must be of standard construction and worth at least £80,000. 
  • You must be a UK resident.
  • You need to get home equity release advice from a financial adviser before taking out a home for life plan.

Is releasing equity a good idea?

It is very important to fully understand the advantages and disadvantages of equity release before making any final decisions.

Pros

  • The cash you receive from equity release is tax-free. You can use an equity release calculator to work out how much you can borrow.
  • Home reversion plans are not a loan, so there is no interest for you to pay.
  • There are no monthly repayments for either equity release products.
  • You get to continue living in your house without needing to sell or downsize.
  • All lenders are authorised and regulated by the Financial Conduct Authority and the Equity Release Council. The Equity Release Council includes protections into every plan. For example, their no-negative equity guarantee means you will never owe more than the market value of your home.

Cons

  • You will not be able to leave your home to your loved ones. Instead, it will be sold after your death or once the last homeowner moves into long-term care. The proceeds are used in order to repay the loan and all the interest that has rolled up.
  • Equity release is not suitable for anybody living with dependents.
  • Additional fees may be involved in the application. You may need to pay for valuation of your property, for legal and arrangement fees, and to receive financial advice from a specialist.
  • Home for life plans and lifetime mortgages are both lifelong commitments, as their names suggest. It is very difficult and expensive to end the agreement early. You must be certain that you want to make this commitment when you decide to release equity from your property.
  • Equity release can negatively impact your entitlement to benefits now and in the future. Your tax position and eligibility for means-tested benefits like pension credit may be affected.
  • You will receive money based on a certain loan-to-value (LTV) percentage of your property’s full market value. The average LTV rate for lifetime mortgages is around 25 to 35%. In home reversion schemes, a share of a house is normally bought for between 30 and 60% of the normal market value for that share.
  • You will not be able to take out any other loans secured against your home in retirement.
  • Lifetime mortgages have fixed interest rates for life, so debt can build up quickly.

The short video below gives more advice about the pros and cons of equity release.

Can you pay back equity release?

The answer to this question depends on which of the main types of products you have taken out.

  • If you have a home reversion plan, you can buy back the share of the property that you sold at full market value.
  • You cannot usually pay off lifetime mortgage equity release plans before the end of your term. If you do, you will be charged an Early Repayment Charge.

 

So, paying back equity release is possible but can be very expensive.

Given that lifetime mortgage equity release interest rates are fixed for life, this means that debt can grow quickly and little to nothing may be left to your estate.

However, some lenders do offer features like Inheritance Protection as an option when customers apply for an equity release plan. This will ring-fence a percentage of the proceeds from the sale of your home to leave to your family when you die. But the more wealth you choose to secure for your estate, the less you will be able to borrow with the loan.

It is also important to remember that equity release is a lifelong commitment, and if you want to leave the agreement early you will need to pay an Early Repayment Charge. This charge can cost a lot of money, so you must make sure you understand the risks when signing your deal.

An independent financial adviser can help you understand the terms of your contract and the features of the equity release products you are considering before you make any final decisions. It is essential that you receive this professional advice before releasing equity from your home.

There are a couple of other ways you can potentially control your debt and leave more inheritance to your family.

Flexible lifetime mortgages

Even though you usually can’t pay off your equity release debt early, a flexible lifetime mortgage can help stop the interest from getting out of control.

This kind of equity release service lets you make ad-hoc monthly repayments from your pension savings or retirement income towards the interest that is building up on your loan.

These payments are optional, so you can choose to pay them only when you can afford to. Flexible mortgage customers are allowed to repay a maximum of 15% of your initial loan amount in this way per year.

"Equity release products allow you to unlock cash tied up in the value of your property. The way the release of equity will work depends on which type of product you select."

Drawdown lifetime mortgages

For similar reasons, some people alternatively choose a drawdown lifetime mortgage.

When releasing equity from mortgage plans with a drawdown facility, you will receive an initial tax-free lump sum as well as access to a special reserve savings account. You can later withdraw money from this reserve account as you need it.

You will only need to pay interest on the money you have actually received, so you might not need to repay as much interest as you would in standard lump sum equity release schemes.

disadvantages of equity release

Does equity release affect benefits?

Yes. When you release equity from your property, your benefits (such as pension credit) may be affected.

In addition to losing your eligibility for means-tested state benefits now and in the future, your tax position may also be affected. So, you could be charged more money as tax.

A financial advisory service will be able to answer any questions you have about how equity release would work in your individual circumstances. They can talk you through potential changes to your pensions.

What are the alternatives to equity release?

If you aren’t convinced that equity release is the best solution for you and your estate, you might want to consider some of the most popular alternatives.

Downsizing your property

A simple alternative is to downsize. By moving to a new, smaller property, you should get a cash lump sum from the proceeds of the sale and use this to supplement your pensions.

You can then use this money in whatever way you like (just like you would be able to with the money you get from equity release). You could make home improvements, repay debts, or help a loved one who is struggling financially.

It is important to remember that there will be extra cost involved with moving to a new property. However, your benefits and tax position would not be affected, and you would be able to leave your new home to your estate to inherit.

Downsizing could also save you money over the long term, by reducing the cost of your regular bills for things like energy.

Retirement interest only mortgages

Interest only mortgages in retirement give you a single cash lump sum. You then need to make interest payments on this borrowed amount every month.

You may need to provide financial details about your retirement income when you take out this product. This is to prove that you can afford the monthly interest rate.

Whichever option you decide you are most interested in, take care to speak to a specialist adviser. Whether you want to release equity or not, the adviser will be able to give you a personalised illustration of how your decision will impact your finances immediately and in the long term.



Other articles that you may find useful

is equity release a good idea

Many people consider equity release in later life but are unsure of whether or not an equity release product will be a good fit for their situation. This article help you understand if it is right for you.

how does equity release work?

Equity release can be confusing at times.  This in depth articles explains how equity release works, who the main providers are and the different type of products available today. We also expllain the pros and cons of taking out a scheme.

pros and cons of equity release

There are several key pros and cons to taking out an equity release product. This article examines the range of advantages and disadvantages associated with equity release. A worthwhile read if you are considering your options.

Lifetime mortgages are a popular type of equity release where you take out a loan secured against the value of your home. This type of scheme allows you to unlock money that is currently tied up in the value of your property.

equity release calculator

Most kinds of equity release calculator online are free to use.  All you have to do is fill in some basic information about your individual circumstances, and you will be shown an instant quote.

Home Reversion Plans

A home reversion plan is a scheme where you sell all or part of your home to a home reversion company in return for tax-free cash.  The money you release with a home reversion scheme can either be a cash lump sum or a regular income

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