Equity Release Schemes Explained

Equity release schemes allow homeowners aged 55 and older to release some of the equity tied up in their home. There are two main types of equity release plan available today – lifetime mortgages and home reversion plans.

Anthony Beachey Last updated on 25 August 2022.
Equity Release Schemes Explained

Equity release schemes provide access to the cash, or house equity, that’s tied up in your home. These plans are aimed at people aged over 55 and allow you to release cash as a lump sum, in smaller amounts or as a mixture of both. However, equity release can prove expensive and risky, so it’s important to fully understand the two main equity release options available.

Types of equity release scheme

Lifetime mortgage

The most popular form of equity release plan – the lifetime mortgage – involves taking out a loan based on the value of your home, which must be your main residence. This particular type of equity release lets you release some of the cash tied up in your property while allowing you to live there until you die or move into a care home. If you have a partner, they can stay in the home until they die or move into a care home. When the house is sold, the proceeds will be used to pay off the loan.

You can take the money as one lump sum, in smaller, regular amounts as a form of income, or as a combination of both. You may also have the option to increase the amount you’ve borrowed up to a maximum sum agreed with the lender.

Interest will be charged on the loan taken out using a lifetime mortgage. But unlike a traditional mortgage, where this will be paid off as you go, interest on a lifetime mortgage can be rolled up and doesn’t need to be paid off until you die or move into a care home. At this stage your home is sold to repay both the loan and the accumulated interest. Some providers allow you to make interest payments during the loan term to reduce costs.

Any funds that remain once your debt has been repaid can be passed on to the beneficiaries of your will. Most lifetime mortgages offer a ‘no negative-equity guarantee’, which means the total amount you owe will never exceed the property’s value. However, in the absence of such a guarantee, if the sale value of the house is less than the amount that needs to be repaid (i.e. you have negative equity), your beneficiaries might have to use other funds from your estate to pay off the outstanding amount.

As long as you live in the house, you remain its owner and will be responsible for its maintenance and paying associated bills, such as council tax.

How much equity you can release will vary depending on factors such as the value of your home, your health and your age. The older you are when you apply, the more you will be able to borrow.

» COMPARE: Lifetime mortgage deals

Home reversion plan

With a home reversion plan, a provider buys all or part of your home (for example, 50% of its value), and in return, you receive either a tax-free cash lump sum, regular payments or both. Although you no longer own the residence, or at least not all of it, you and your partner have the right to remain there rent-free for the rest of your lives or until you move out. You can continue to regard the home as your own without interference from the provider.

You won’t pay interest on the money, but instead, your lender pays less than the going rate for your property. Generally, you’ll be allowed to take between 30% and 60% of its market value, depending on your age. The older you are, the higher the percentage of the property’s value you’re likely to receive.

» MORE: How home reversion plans work

Pros and cons of equity release schemes

Advantages of equity release

  • Equity release schemes allow you to withdraw some of the wealth stored in your home without having to move.
  • You can withdraw tax-free cash to cover major expenses, such as private medical treatment and home improvements, or to simply fund a more comfortable retirement.
  • Equity release plans are regulated by the Financial Conduct Authority (FCA), an official body designed to protect your financial interests. You can complain to the Financial Ombudsman Service if you’re unhappy with the service you receive from an equity release provider.

Drawbacks of equity release

  • Interest rates on lifetime mortgages are generally higher than on a standard mortgage.
  • Rolling up interest, rather than making regular repayments, will add to the expense of the loan.
  • There may be little or nothing remaining in the value of your home to pass on as an inheritance.
  • Equity release plans have arrangement fees and require you to pay other charges, including for legal advice.
  • Equity release can impact your eligibility for pension credit, savings credit, council tax reductions or other means-tested state benefits.

» MORE: Is equity release right for you?

Alternatives to equity release schemes

Taking out an equity release plan is not a decision to be taken lightly – indeed, you’re obliged to take financial advice before you can.

Before you proceed, it’s important to consider the alternatives to equity release first. For example, if you’re able to do so, remortgaging may offer a cheaper means of releasing cash from your home.

Or perhaps you could downsize, by selling your current home and moving to a cheaper alternative, releasing some of the equity you hold in the process.» MORE: 6 options to consider before choosing equity release

Source: Getty Images

About the author:

Anthony is a BBC-trained journalist. He has worked in financial services and specialised in investments for over 20 years, writing for various wealth managers and leading news titles. Read more

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