How do equity release interest rates work?

There are two main types of equity release in the UK, both intended for homeowners aged 55 and older who want to access some of the money tied up in their home without having to move.

Lifetime mortgage

A lifetime mortgage is a long-term loan secured on your home available to UK homeowners aged 55 and over. This is the most common type. With a lifetime mortgage, you’ll borrow money against the value of your home. This means, you’ll still own your home and can live in it through your retirement. Typically, you don't have to make mandatory monthly repayments because the interest is added to the loan. Unlike a residential mortgage, with a lifetime mortgage there are no monthly repayments. Instead interest is added on a compounded basis which quickly increases the amount owed. Typically the loan is repaid when you (and your partner, if you’ve taken it out jointly) pass away or move into long term care usually from the sale of the property, subject to terms and conditions. Inheritance will be reduced and welfare benefits may be affected. 

Home reversion plan

This is less common and doesn't work the same as a lifetime mortgage. With this type of equity release, you’ll sell part of your home to a provider in exchange for a lump sum or regular payments. You’ll be able to live in your home rent-free (or small rent fee) for the rest of your life. And when the property is eventually sold, the provider gets a share of the proceeds. It's worth noting that we don't offer this type of equity release.

By building your confidence in understanding how equity release interest rates work, you may have a better foothold on whether it’s the right choice for your retirement years. In this section we'll be looking at the interest rates that can apply to lifetime mortgages.

Fixed interest rates 

One of the key features of equity release interest rates, specifically for lifetime mortgages, is that they are fixed for the length of the policy. This means that once you agree to a rate, it will not change regardless of shifts in the broader financial market. Fixed interest rates may give you certainty and stability, allowing you to plan your finances.

Compound interest

Lifetime mortgage interest rates are typically compounded, meaning that interest is charged over the year on the total amount borrowed, as well as on the interest that has already been added. 

This could mean a rapid increase in the amount owed over time. For example, if you borrow £50,000 at an interest rate of 5%, the interest for the first year would be £2,500. In the second year, interest would be charged on £52,500, and so on. This compounding effect can significantly increase the total amount you owe, so it's important to understand how it works.

Personalised rates

For some lenders, interest rates for lifetime mortgages are not one-size-fits-all. Instead, like with Aviva, they are personalised based on individual circumstances. But, it's always important to check with your lender. Factors such as your age, health, and the value of your property can influence the rate you are offered. 

Some of the factors that influence lifetime mortgage interest rates include:

• Health and lifestyle: Lenders may offer different rates based on your health and lifestyle. For example, some health conditions might qualify you for a lower interest rate.
• Age: Generally, the older you are, the more you can borrow, and this can also affect the interest rate offered.

Understanding the interest rate and repayment options on your lifetime mortgage is critical to minimising overall costs. Recognising the options available can help you tailor your approach so that it fits within your financial circumstances and goals. 

Regularly reviewing your plan and making informed decisions about repayments can help you control the growth of your debt. 

Voluntary repayments

Some lifetime mortgage plans let you make voluntary repayments. This can help reduce the growth of the total amount you owe. For example, it could be that each year the maximum amount you can repay is 10% of the initial loan, including any additional borrowing and cash reserve releases, excluding any accrued interest. 

Making voluntary repayments can be a great way to reduce the amount owed over time, but it’s important to think about your individual situation. It's worth weighing up the pros and cons, including whether the money could be better used elsewhere. There are many factors which could influence your decision, and it's often a good idea to seek financial advice to help you understand what's right for you. Something to think about is the risk of negative equity. This is where the balance of a lifetime mortgage is higher than the sale price of the property when the loan becomes repayable. If payments are less than the interest added and/or the value of your property goes down, negative equity may still happen even after making voluntary repayments. That means, it’s important to consider the effects of compound interest and property values before deciding if and how much you would like to repay.

If you’re unsure about the amount to repay, consult your financial adviser. If you don’t have a financial adviser, check out Unbiased (keep in mind you’ll be charged for advice) or MoneyHelper for further guidance. There may be limits and conditions for these repayments, so it's important to understand the terms of your specific plan. 

When exploring lifetime mortgages, it's important to weigh the long-term impacts on your financial wellbeing. 

Loan amount

As you’re thinking about your projects, plans and adventures in retirement, it's important to borrow only what you need in the moment. Borrowing more than what you need can lead to a larger debt because of compounding interest. By taking out only the amount you need, you can better manage the growth of your debt and keep more equity in your property.

Cash reserve facility

A cash reserve facility allows you to get more money as needed, without being charged interest on the entire amount upfront. Interest is only charged on the amount you withdraw from the reserve, and the rate at the time of withdrawal may vary. But it's worth noting that this cash reserve facility can only be added at the time of setting up the lifetime mortgage. There is a choice of taking a one off lump sum or a one off lump sum and an amount set in a cash reserve facility to draw from as and when they money is required. This can be a flexible way to manage your finances, as you only pay interest on the money you use.

Equity reduction

As the debt from a lifetime mortgage increases, the available equity in your property decreases. This can impact your ability to borrow more in the future or leave an inheritance. Understanding how the increasing debt affects your equity is important for long-term financial planning.

To learn more about lifetime mortgages, check out our guide on equity release. And our equity release calculator could help you crunch the numbers.