Staying put: equity release

This article is to provide you with an overview of the equity release market and is for information only.  

It’s always been difficult to persuade some self-employed people to save into a pension. They tend to say “my business is my pension”.  Increasingly, we now hear a variation on this theme from people both employed and self-employed: “my house is my pension”. 

To turn this ‘pension’ into spendable money, downsizing was once widely regarded as the only viable option. But under the right circumstances, this is certainly no longer the case.

Equity release is a way of releasing value within your home by using a financial product. There are two main ways to release equity:

  • Lifetime mortgage

  • Home reversion

Lifetime mortgages

By far the most common way to release equity from your home is to take out a lifetime mortgage. These are available from age 55 onwards and, like home reversion plans, the younger you are the less you will be able to release. 

In the case of a lifetime mortgage, you aren’t actually selling your home. The big difference from a normal mortgage is that you don’t have to make any repayments of either capital or interest. This means the capital borrowed, and the interest on it, roll up over time. It also means that you pay interest on interest as well as interest on the original capital amount borrowed – this quickly increases what you owe.

Current lifetime mortgages allow the borrower(s) to continue to live in their home until they die or move permanently into care. At that point, the house is sold.

If the sale raises more money than the initial borrowing and rolled-up interest, the difference is returned to the borrower’s estate. 

If the sale realises less than the initial borrowing and rolled-up interest, there is usually no debt on their estate. This is because most products now carry a ‘no negative equity’ guarantee. In other words, you will never owe more than the amount raised by the sale of your home, so long as it’s sold for the best price reasonably obtainable.

Some lifetime mortgages allow the borrower to specify that a set amount or percentage of the final value of their home is returned to their estate for distribution to their beneficiaries. If they choose this option, they won’t be able to borrow as much.

It may be possible to repay a lifetime mortgage early, in part or in full. You might choose to do this if, for example, you inherited money. There may, of course, be early repayment charges which could be substantial if you choose to do this.

The following table sets out an indicative maximum amount that you might be allowed to borrow for a couple (joint mortgage). The age of the youngest borrower is used to work out the loan amount:

Age of youngest in the couple

Maximum percentage of home valuation that can be borrowed

60

24.5%

65

29%

70

35%

75

40%

80

46%

Source: Aviva

Finally, let’s look at the pros and cons of lifetime mortgages:

Lifetime mortgage pros

Lifetime mortgages cons

Unlike downsizing, there’s no need to move home – and you get to live there until the last survivor dies or moves permanently into care. Terms and conditions may apply.

You are paying interest on the amount borrowed and interest on interest. This means your debt grows quickly over time.

You may be able to choose a product that allows you to draw down money as and when you need it rather than in one lump sum.  This means you only pay interest on money taken

The maximum amount you can borrow is significantly less than your house is worth. 

Unlike home reversion (see below), your house and any growth in its value still belongs to you – although you now also owe money, which has to be offset against any increase in value.

If you decide to repay the loan early, this can be expensive as you may have to pay an early repayment charge in addition to the amount owed. An early repayment charge is most likely to apply where interest rates have fallen since you took out the lifetime mortgage.

Most equity release products now include ‘no negative equity’ guarantees and allow you to leave an inheritance to the next generation. And, you can repay the loan early if you want to – although substantial early repayment charges may apply.

The amount available to the beneficiaries of your estate will be lower, or possibly nothing, unless the borrower chooses an inheritance guarantee option.

If a lifetime mortgage is the right option for your circumstances, you will reduce the value of your estate which could be beneficial for inheritance tax purposes.

Taking out equity release could affect your tax position and any possible entitlement to state benefits.

The cash you receive is tax-free.

 


Home reversion

Home reversion plans have become less common in recent years. With a home reversion plan, a financial services provider buys all or part of your home at a discount to its true market value, in return for a cash lump sum or regular income payments. You also retain the right to continue to live in the house until you move out – say into residential care – or die.

The younger you are, the less you will get as a lump sum. Or, looking at it the other way around, to generate a given lump sum you will need to be prepared to surrender more equity in your home if you are younger.  

As a rough guide, a 65-year-old couple who surrender all of the equity in their home would receive a cash lump sum around 28% of its value. Whilst this may seem like quite a small amount, remember that you get to live rent-free in the house for life. 

The older you are, the greater the cash value that you are likely to get. For example, a 75-year-old couple would receive about 42% of the value of their home by surrendering all of the equity.

Other things that worry people about home reversion plans are that their property might grow in value by more than expected, but they don’t get to share in that increase. And, if they die or move into nursing care early, they haven’t enjoyed the use of their home rent-free for as long as expected. 

It is possible to protect against these worries, but that will usually mean a lower cash value is received.

Let’s have a look at the other pros and cons: 

Home reversion pros

Home reversion cons

As the cash you receive is not a loan, you don’t have to pay any interest on it.

You no longer own part or all of your home.

Unlike downsizing, there is no need to move home – and you get to live there until the last survivor dies or moves permanently into care. Terms and conditions may apply.

The cash you receive is at a large discount to the true market value of your home or the part of your home that you have sold.

Assuming your property is your principle private residence, the cash you receive is tax-free.

If you die or move out soon after taking a home reversion plan, you will have sold your home for less than it was worth, but received little in return to compensate.

You can protect against early vacancy and high house price growth but this will reduce the amount you can borrow.

If you want to end the plan early, you will usually have to buy back the part of your home that you sold and, in the process, pay a lot more than you received as a cash lump sum.

If a home reversion plan is the right option for your circumstances, you will reduce the value of your estate which could be beneficial for inheritance tax purposes.

The plan may prevent you moving to a new house or accepting new occupants (for example children who have come back to stay) without the agreement of the new owner.

 

Taking out equity release could affect your tax position and any possible entitlement to state benefits.

General points worth thinking about before you enter into a home reversion plan or lifetime mortgage: 

  • One cause of complaint is the valuation placed on the home. Make sure you are familiar and comfortable with the valuation and sale processes before you go ahead.
  • Another cause of complaint comes from the wider family – usually that they have lost what they thought was their inheritance.  Although there is no requirement to involve your family when you take equity release, most families are likely to be supportive and it can help avoid bad feelings later on.
  • There are financial costs involved in arranging equity release, such as valuation fees and legal expenses (these costs also apply if you downsize).
  • Many people consider using up savings first before thinking about equity release. 
  • Equity release (and generating capital from downsizing) may affect your entitlement to welfare benefits such as Pension Credit and Council Tax Reduction. A financial adviser should be able to explain if or how you might be affected.
  • You should consider only taking out what you need. There is no point surrendering equity or paying interest on money that is then moved to a deposit account earning a meagre rate of interest. 
  • You will need to take financial advice before entering into equity release. Some financial advisory firms specialise in this type of advice. Take your family with you to see the adviser, so that they can ask questions too. 

If you’re not sure if equity release is the right option for you, speak to your financial adviser. If you don’t have a financial adviser, you can find one in your area at www.unbiased.co.uk.


AR01578 12/2015

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