For many, owning a home is about more than just having a place to call your own. It can also be an investment that can potentially offer financial security as you grow older. This is because house values grow over time as a result of house price inflation driven by consumer demand.
But how can you access the equity that may have grown in your property as you get older?
Homeowners in the UK who are over the age of 55 do not have to sell their home to access their equity. Instead, this can be harnessed through a process called Equity Release.
Equity release is a blanket term which covers a couple of different financial products. These are essentially long-term loans taken out against the value of a home whilst remaining in it, in exchange for either a lump sum or regular cash payment from the provider.
In this blog, we explain how equity release works, the different types of equity release products available to UK consumers, their benefits, and the risks and dangers they can pose.
How does Equity Release work?
Specifically designed for homeowners who are aged 55 or over, equity release is a financial product that allows you to ‘release’ or ‘unlock’ the value or ‘equity’ tied up in your property. This involves establishing the potential amount to be released through a property valuation and legal work.
In practical terms, equity release transforms the value of your home into a cash lump sum, a regular income, or a combination of both, without requiring you to move out. The reason behind choosing equity release varies. It can serve as supplemental income during retirement, fund significant expenses, or even to help your family financially.
If a property is co-owned, such as by a married couple, the age of the youngest owner must be above the age limit for the equity release scheme in question.
What are the different types of Equity Release?
Equity release schemes can primarily be broken down into two categories: Lifetime Mortgages and Home Reversion Plans.
Each of these works in a slightly different way and has its own distinct benefits and downsides.
What is a Lifetime Mortgage?
A lifetime mortgage is a loan secured against a property, which doesn’t require regular repayments, and instead is paid back by selling the property when the homeowner passes away or moves into permanent residential care.
This type of scheme is normally available for people aged 55 and upwards. The interest rate on the loan can be either fixed or variable.
Generally, lifetime mortgages come with something called a “no-negative equity guarantee”. This guarantee means your debt will never be allowed to exceed the market value of the home it is secured against.
How does Home Reversion work?
Home reversion is another form of equity release scheme, albeit one which is less common than a lifetime mortgage.
This type of scheme is generally available to homeowners aged 65 and over. With a home reversion plan, you sell part or all of your home to a home reversion provider in exchange for a lump sum or regular payments.
Despite selling all or part of your home, you retain the right to live in your property, rent-free, for the rest of your life. This right remains intact regardless of how much of your home you’ve sold, subject to the terms and conditions of your equity release agreement. The amount you receive from the provider is typically below market value since the provider cannot sell the house until you pass away or move into permanent care.
Home reversion plans can be a viable option for those who do not wish to leave a property as an inheritance or who only want to ring-fence a portion of their property’s value for inheritance purposes.
What are the benefits of releasing equity from Your home?
The main reason you may wish to use an equity release product is to ensure access to a lump sum of cash. You may decide to do this rather than selling your property in a hurry to access money tied up in it.
This can be important for a variety of different reasons for different people, with uses ranging from funding living expenses and supporting family members and friends in emergencies or difficulties, to providing the cash for a more extravagant lifestyle. In effect to enjoy later life.
A core benefit of all equity release products is the guarantee you can stay in your property until you pass away or need to move into residential care. This security gives equity release products a huge advantage over conventional mortgages.
Additionally, a less frequently highlighted benefit is the portability of equity release products. This means that even after releasing equity, you retain the option to sell your current property and relocate, thus providing another layer of flexibility and control over your living arrangements.
Understanding the risks and disadvantages associated with equity release products
Equity release products do come with a number of disadvantages.
Firstly, by their very nature, equity release products are loans and as such accumulate interest, which can build up significantly. This could potentially lead to a scenario where, when the loan is finally repaid, there is little or nothing left to pass on to heirs to inherit.
However, most equity release products incorporate a crucial safeguard known as a no-negative equity guarantee. This prevents the accrued debt from ever exceeding the value of your property, protecting you from significant financial risk. It’s important to note that unscrupulous providers might not include this guarantee, putting you in potential financial jeopardy.
For assurance, look for providers who adhere to the Equity Release Council’s product standards. Registered providers are required to include a no-negative equity guarantee in all their equity release products. By ensuring your chosen provider is a member of the Equity Release Council you can effectively mitigate one of the key risks associated with equity release schemes.
There are also other downsides to equity release.
By increasing your assets, you can make yourself ineligible for some state benefits, and while many equity release providers will allow you to move home, they will place limitations on the types of property you can buy.
Finally, equity release can be extremely difficult and expensive to escape from. In addition to having to raise the funds to pay back your loan, you may also need to pay a large repayment fee if you decide to back out of the scheme.
How should you release your capital?
Most equity release schemes allow you to choose how you receive the capital you are freeing up.
Some people choose a one-time payment, which they may then invest in a savings account, while others pick a regular monthly income.
There is also a third, more flexible option, the drawdown mortgage. A drawdown mortgage allows you to access your money in a flexible manner by taking an initial lump sum, and then leaving the rest of your funds in a reserve account facility that you can draw from as needed.
The way in which you choose to do this can be one of the more important financial decisions you will make.
In the following section, we look at the benefits and downsides to each method.
Single Lump Sum: Benefits
Opting for a single lump sum means you receive the entire loan amount all at once.
This approach can be highly beneficial if you have immediate and large expenses such as repaying an existing mortgage, performing extensive home renovations, or clearing other significant debts.
Moreover, a lump sum can provide the means for substantial investments to secure a decent income, or for assisting family members financially on a larger scale.
Single Lump Sum: Downsides
The key downside of a lump sum is that interest begins to accrue on the total loan immediately, and this can compound quickly if it isn’t managed. While you will not be charged this directly, it can quickly reduce the value of your estate dramatically.
While the lump sum doesn’t directly affect your tax bracket, as the money received from equity release is tax-free, by investing the money and generating income from it, you could potentially increase your income enough to affect your tax position.
Furthermore, receiving a lump sum could affect your eligibility for means-tested benefits, including Universal Credit and Child Benefit.
Regular Income: Benefits
Some equity release schemes offer the option to receive an income made up of regular payments.
This option essentially turns your property into a sort of pension, providing you with a steady stream of income that can be a great way to supplement your retirement.
Regular Income: Downsides
Often this method ends up providing a lower overall cash amount compared to a lump-sum release.
In addition, similarly to a lump sum, receiving regular income could also potentially affect your tax position if this income is invested and generates returns. It may also impact your eligibility for means-tested benefits if it pushes you over a relevant income threshold.
Drawdown Lifetime Mortgage: Benefits
A drawdown lifetime mortgage offers you greater flexibility than the previous two options.
You can take a smaller initial amount and then draw further funds as and when you need them.
The primary advantage here is that interest is only charged on the funds you’ve withdrawn, not on the total amount that is available to you. This can substantially reduce the total interest you end up owing.
Typically, drawdown mortgages are only available with lifetime mortgages, and not as part of a home reversion scheme.
Drawdown Lifetime Mortgage: Downsides
Drawdown lifetime mortgages typically have a few downsides compared to a lump sum, or a regular income.
Firstly, if you immediately need a large sum of cash, this product is unlikely to be ideal for you. Typically you are limited to smaller initial lump sums than if you were taking out a lump sum mortgage.
In addition to this, drawdown plans are more complex than other forms of equity release, and it is important to ensure you are clear on the schemes terms before you take such a loan out.
In summary
Equity release can be a great way to leverage the value tied up in your home in the later stages of life.
However, it’s essential to carefully consider the advantages and downsides of the different types and methods of equity release.
Given the long-term impact and potential complexities, professional advice is not only recommended but is mandatory under regulations from the Financial Conduct Authority in the UK. As with all big financial decisions be sure to consult with a financial adviser to ensure you’re making the best decision for your financial future.
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