Equity release is a way of releasing cash from your home without having to move. But it’s not without its risks. Let’s take a closer look at everything you need to know.
What is equity release?
Equity release is a way for older homeowners to access some of the money tied up in their home without having to move.
The money can normally be taken as a lump sum, regular payments, ad-hoc payments (known as ‘drawdown), or a combination of these.
People usually use equity release to fund their lifestyle in retirement, improve or renovate their home, help their children on to the property ladder, or pay off debts.
How does equity release work?
Equity is the difference between how much debt you have secured on your home and the current value of your home. For most people, their mortgage will be the only debt secured on their home. Many homeowners will have paid off their mortgage before they get to the age when they think about equity release – the minimum age is 55.
If your home is worth more than debts secured on it, you have equity or are ‘in positive equity’. Equity release allows you to use this equity in your home without selling up, so is ideal for people living in high-value houses but with insufficient cash for day-to-day living.
Equity release explained
There are two main types of equity release.
- Lifetime mortgage
- Home reversion plan
How does a lifetime mortgage work?
A lifetime mortgage is the most common type of equity release. How much you can borrow will depend on your age and how much your property is worth. The older you are, the more you can borrow. Sometimes your health will be taken into consideration as well.
With a lifetime mortgage the debt, plus interest, is repaid from the sale of your home when you die or move into long-term care. You normally don’t pay anything towards your debt each month – the interest is ‘rolled-up’ and added to what you owe at the end.
Interest rates on lifetime mortgages are about 4% to 7% – so considerably higher than a normal mortgage. The rate can either be fixed or variable with a cap.
In theory, if you borrow a large amount of money and live a long time, interest charges mean you could end up owing more than your property is worth, known as negative equity. However, most lifetime mortgages have a ‘no negative equity guarantee’, which means you’ll never owe more than your property is worth.
How does a home reversion plan work?
With a home reversion plan, you raise money by selling all or a proportion of your home while continuing to live in it. As with a lifetime mortgage, the debt is repaid when you die or move into long-term care.
At this point, your home is sold and your estate will receive back your share of the sale proceeds, minus the share sold to the reversion provider. For example, if you sold 30% of your property to a home reversion company, it would receive 30% of the proceeds, including any increase in the property’s value.
Home reversion plans are not as common as lifetime mortgages.
Who is eligible for equity release?
You need to be at least 55 to take out a lifetime mortgage, and 65 for a home reversion plan.
You’ll need equity in your property and any outstanding mortgage must usually be cleared with the funds from the equity release.
Your home will need to be in a reasonable condition and meet certain other terms.
The downsides of equity release
Although equity release sounds great, it comes with certain pitfalls. These usually affect your family more than you. If you have dependents living with you, they may find themselves with nowhere to live when you die or move into care.
It will also impact the amount of inheritance you’ll have left to pass to your family when you die. As the equity release company will take its share of the money before the remainder is shared out. Selling with an equity release plan can also be difficult.
In general, it can be an expensive way to borrow money. You should discuss other options with a financial adviser before going down this route.
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Last Updated: August 9th, 2022