You’ve heard the term countless times, but do you know exactly how equity release schemes work? In this week’s post, we’re going to answer many of the common question regarding equity release, including how it works, what it costs, and how safe the schemes are.
Let’s jump straight in!
What is equity release exactly?
In short, equity release plans enable homeowners to unlock some of the cash that is currently tied up in their property. Aimed solely at older homeowners, equity release schemes can seem like a good idea to those who need, or want, to raise funds without having to sell their home and move out.
Once signed up to a scheme, the homeowner will receive cash which has been ‘released’ from the equity that has accumulated on their property over the years. There are a couple of ways in which homeowners can access their equity and they can still be eligible for an equity release plan even if they have an outstanding mortgage left on your property, although applicants do need to be 55 or over to qualify.
How the cash is paid can vary between lump sums, smaller increments, or a combination of the two.
Wouldn’t downsizing be a better option?
For many, yes it would, but you do need to move in order to downsize, hence the attractiveness of equity release to those who do not want to go through the rigmarole of selling, packing up, and moving home.
For more information on downsizing, check out our guide to downsizing your home.
How does equity release work?
As we’ve already touched on above, in order to qualify for an equity release plan you’ll need to be a UK homeowner and over 55. Outstanding mortgages are not necessarily a barrier to eligibility.
If downsizing isn’t for you, there are two main types of equity release schemes available to homeowners:
Probably the most common of the two, lifetime mortgages are pretty much what they say they are: a mortgage that stays with you until you pass away.
Lifetime mortgages allow you to borrow/access/release money from the value of your home at a fixed rate. Many older plans were repayment free, which sounds great until you calculate just how quickly that interest mounts up in the absence of any money going back into the kitty.
There were (understandably) many complaints about the above method of financing, so lenders have started to offer an alternative where borrowers can make repayments should they wish to do so. While some will only allow you to chip away at the interest, others give you the opportunity to pay off some of the capital, too, making the deal much more attractive.
Another benefit of some ‘drawdown’ mortgages is that you can take your money out in chunks, rather than one hit, and pay interest only on the amount received rather than the whole sum.
The second type of equity release scheme is home reversion. Eligibility for this type of plan is restricted to those aged 60 and over.
Home reversion differs from a lifetime mortgage because you are effectively selling a portion of your home to the provider of your choice below market value. You will be able to live in the property rent-free until you shuffle off this mortal coil, but the provider will be entitled to the percentage they own when the property is eventually sold.
This can be a very good deal for the lender, as house prices will generally rise significantly over the long term. For example, say you own a property valued at £350,000 and wish to release 20% to receive £70,000, that £70k will quickly become £100,000 should your home be revalued at £500,000 at the time of sale...a tidy profit of £30k for the lender, which is an increase of just short of 43% on 20% of your property!
If you knew for certain that house prices were going to stagnate for the rest of your days, home reversion would be the better deal of the two. Historically, however, house prices rise, so the majority of equity releasers opt for lifetime mortgages.
How much can you borrow?
As with so many questions asked in life, the answer is: it depends.
A number of factors go toward calculating the amount of money you can draw from your equity, including the property’s value and your age. If the equity release scheme is to be taken out jointly between partners, the youngest applicant will be one the plan is based around.
That said, there are generalisations we can look at. Lifetime mortgages are usually somewhere around the 50% mark, but be aware that if you’re at the younger end of the scale you may be offered far less.
Home reversion is a little different. In some instances, you may be able to ‘sell’ the whole property to the equity release firm, but again age will come into play here. The older you are, the more they’re likely to offer you.
How much does equity release cost?
As one might expect, lifetime mortgage rates come in significantly higher than standard mortgages. At the time of writing, the average is just above 5%. At that level of interest, it’s easy to see just how expensive these mortgages can become if the interest is left to compound.
On top of the cost of interest, it’s highly likely your lender will want an arrangement fee as well. Depending on which equity release company you choose to go with, these can vary greatly and reach as much as £3,000 to £4,000, more in some cases. Oh, and don’t forget stamp duty!
Home reversion costs are slightly different. You will still have to fork out for an arrangement fee and if you take advice, which we strongly recommend, there will be the cost of an advisor as well.
Then there’s valuation and legal fees. Both of these should ALWAYS be carried out by an independent party. Never, ever accept the offer of a valuation or free legal advice from the home reversion firm.
Even though these additional cost can seem unnecessary, having someone unassociated with the deal look over the small print and value your property is the only way to go. Failing to do so opens the door to the possibility of shady shenanigans.
How long does it take to release equity from your home?
Again, each provider will differ, but the process can usually be completed within two to three months.
That said, these timings are based on when your application hits the lender’s desk to when the money is in your bank account, but you should also add a considerable amount of thinking time into the equation. Equity release is not something that should entered into lightly.
How safe are equity release schemes?
Providing you opt for a provider who is part of the Equity Release Council (ERC), equity release schemes are very safe. Members of the ERC all offer the guarantee of ‘no negative equity’, which means there’ll be no debt left to the estate and you’ll never owe more than the value of your home.
However, just because something is safe doesn’t necessarily mean you should do it...
Should you release equity from your property?
As you can probably imagine, the decision over whether or not equity release is right for you can only be made after taking into consideration your own personal circumstances. You should think long and hard before diving into something as irreversible as this and take professional, independent advice first. It may be another expense, but it could prove to be small change compared to a costly mistake.
It’s important to remember exactly what is happening here. Equity release is reducing the value of your estate, no matter what way you cut it. If you have plans to leave a nest egg to loved ones, you must be aware that, should you spend the money taking from your equity, their inheritance will be significantly less when the time comes to pass on your estate.
In this instance, it’s always worth discussing your situation with loved ones, too. If you need cash, they may be able to offer help to you now and protect their inheritance later. You should also talk to them if you’re thinking of going through with equity release in order to raise funds to help them. While it’s a nice idea and could get them out of a tight spot, they may be vehemently opposed to you doing so. You wouldn’t be the first family to fall out over this, so opening up dialogue is advised.
All in all, equity release can work well for some, but for others there may be better options available or they could choose a completely different route in order to ease their financial concerns. Take advice, talk to your family, and don’t let salesmen persuade you it’s all rainbows and unicorns.