If you’re retired and living on your pension, you may be finding money is a bit tight. If you own your own home and are in your mid-50s or over, you may be thinking about equity release because it could provide you with a lump sum or additional income. You might also consider equity release for tax-planning reasons.
Before considering equity release
It’s important to check whether there are other ways you could meet your financial needs before choosing an equity release scheme.
Some ways might be to:
- claim any benefits you might be entitled to;
- check to see if your local authority can help you to pay for essential home improvements;
- trace any pensions you may have lost track of, using the Pension Tracing Service;
- use your savings or sell your investments, but consider getting advice before doing so; and/or
- sell up and buy somewhere smaller and cheaper (downsize).
What is equity release?
Equity release is a way of getting cash from the value of your home. These schemes can be helpful in certain circumstances but are not suitable for everyone. For example, they can be expensive and inflexible if your circumstances change in the future and may affect your current or future entitlement to State or local authority benefits.
How does it work?
One way is to borrow a lump sum secured against your home. Another way is to sell part or all of your home to give you a regular income or lump sum, or both. You can continue to live there.
You are more likely to qualify for an equity release scheme if you have no current mortgage, or if any mortgage you have is relatively small.
Types of equity release
There are two main types of equity release scheme:
- lifetime mortgages; and
- home reversions.
They work differently and are quite complicated.
With a lifetime mortgage, you take out a loan secured on your home. This mortgage may be:
- A roll-up mortgage (rolled up means interest is added to the loan – for example, each year). You get a lump sum or regular income and are charged a monthly or yearly interest which is added to the loan. The amount you originally borrowed, including the rolled-up interest, is repaid when your home is eventually sold.
- A fixed repayment lifetime mortgage. You get a lump sum, but don’t have to pay any interest. Instead, when the home is sold, you have to pay the lender a higher amount than you borrowed. That amount is agreed in advance. The lender uses this higher sum to repay the mortgage when your home is sold.
- An interest-only mortgage. You get a lump sum, and pay a monthly interest on the loan, which can be fixed or variable. The amount you originally borrowed is repaid when your home is eventually sold.
- A home income plan. The money you borrow is used to buy a regular fixed income for life (an annuity). This income is used to pay the interest on the mortgage and the rest is yours. The amount you originally borrowed is repaid when your home is eventually sold.
Some lifetime mortgages include a shared appreciation element. This means the lender has a share in the value of your home.
When taking out a lifetime mortgage, you can choose to borrow a lump sum or to opt for a drawdown facility. This is suitable if you want to take occasional small amounts rather than one big loan, as it means you only pay interest on the money you actually need.
How does it work?
As with a conventional mortgage, you borrow money secured against your home. The home still belongs to you. Apart from roll-up schemes and fixed repayment lifetime mortgages, you will have to pay interest on the loan every month. When you die or move out, the home is sold and the money from the sale is used to pay off the loan. Anything left goes to your beneficiaries.
If there is not enough money left from the sale to pay off the loan, your beneficiaries would have to repay any extra above the value of your home from your estate. To guard against this, most lifetime mortgages offer a no-negative-equity guarantee. With this guarantee the lender promises that you (or your beneficiaries) will never have to pay back more than the value of your home – even if the debt has become larger than this.
Is it right for you?
It depends on your age and circumstances. For example:
- With a roll-up mortgage the interest you owe can grow quickly. Eventually this might mean that you owe more than the value of your home, unless you have a no-negative-equity guarantee.
- A fixed repayment mortgage becomes a better deal if you live much longer than the lender thinks you will. But if the home is sold much earlier than you planned, you will get a worse deal.
- An interest-only mortgage with variable interest rates may not be suitable, because the interest rate may rise faster than your income.
- A home income plan only results in a small income after paying interest. It is only suitable if you are older, perhaps around 80.
Lenders will expect you to ensure that the condition of your home is maintained at a good level. You may need to set aside money to do this.
If this could be a problem, an equity release scheme may not be suitable for you.
With a home reversion, you sell all or part of your home in return for a cash lump sum, a regular income, or both. Your home, or the part of it you sell, now belongs to someone else, but you are allowed to carry on living in it until you die or move out.
How does it work?
A company either buys your home or a part of it, or arranges for someone else to do so. In return you get a cash lump sum or an income. If you get a cash lump sum you may decide to invest this yourself to provide an income.
You’ll usually get between 20% and 60% of the market value of your house because the buyer allows you to carry on living there and cannot sell it until you die or move into care. The older you are when you start the scheme, the higher the percentage you’ll get.
You get the right to carry on living in the home under a lease. The terms of the lease will vary depending on which reversion you choose. You usually pay a nominal rent of say £1 each month, or you may have the choice of paying a higher rent in return for more money from the sale.
Is it right for you?
A home reversion can be a useful way of releasing equity from your home but you must be sure it is right for you.
If you do not need anyone else to benefit from the full value of your home, want a lump sum or income now, and want to stay in your home, a home reversion may be worth considering.
But you will no longer own your home (even if you only sell part of it). However, you will still have to maintain the home while you live in it, so you may need to set aside money to do this. You’ll also have to follow the terms of the lease and make regular rent payments. If this could be a problem, then a home reversion may not be suitable for you.
Home reversions are normally best suited to individuals, perhaps over the ages of 70 or 75.