Understanding the different types of equity release schemes
Equity release schemes allow homeowners aged 55 and older to release some of the equity tied up in their home. The two common types of schemes are lifetime mortgage and home reversion plans.
How do equity release schemes work?
Equity release schemes provide access to the cash, or house equity, that’s tied up in your home. They’re aimed at people aged over 55 and allow you to take the cash either as a lump sum or in smaller amounts. However, equity release can prove expensive and risky, so it’s important to think carefully before signing up for a scheme.
Suppose you bought a house for £50,000 back in the early 1990s, and today it’s worth £450,000. If you bought the house by borrowing 90% of the money from a mortgage lender, your stake, or equity, in the house back then was £5,000. Today, having paid off the mortgage, your equity is 100%, or £450,000, so the idea of releasing some of that wealth could be tempting. Equity release schemes allow homeowners aged over 55 to do just that.
The two types of equity release schemes
The most popular form of equity release involves taking out a loan based on the value of your home (as long as it’s your main residence). The lifetime mortgage scheme lets you release some of the cash tied up in the 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 or in smaller, regular amounts as a form of income. You may also have the option to increase the amount you’ve borrowed up to a maximum sum agreed with the lender.
You’ll be charged interest on the loan. But unlike a traditional mortgage, interest usually rolls up in what is called ‘compound interest’ (you’ll pay interest on interest as it accrues). This means that both the loan and the accumulated interest are repaid in full when you die or move into a care home. However, some providers allow you to make some interest payments during the loan term to reduce costs.
You can leave anything left over 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, suppose your contract doesn’t state this, and the sale value of the house is less than the loan you took out (i.e. you have negative equity), your beneficiaries will be responsible for paying off the outstanding amount.
As long as you live in the house, you remain its owner and will be responsible for maintaining it and paying associated bills, such as council tax.
You can normally borrow up to 60% of the value of your property. However, this will vary depending on factors such as the value of your home, your health and your age. The older you are at age of application, the more you will be able to borrow.
» COMPARE: Lifetime mortgage deals
Home reversion plan
Under a home reversion plan, a provider buys all or part of your home (for example, 50% of its value). 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. You can typically expect to get 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.
Pros and cons
- 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.
- Equity release can impact your eligibility for pension credit, savings credit, council tax reductions or other means-tested state benefits.
- You might not be able to leave your home as an inheritance.
- Rolling up interest is more costly than making regular repayments and means your beneficiaries could be liable for a significant interest bill on top of the original loan.
- The contract will be subject to an arrangement fee and other charges, including legal advice.
» MORE: Is equity release right for you?
Costs and advice
In order to get an equity release plan you will need a consultation with a qualified equity release adviser – they will be able to recommend the most suitable plan for you. You may have to pay a fee for this but some organisations such as the debt charity Step Change offer free equity release advice. You will also need to pay for legal advice.
Arrangement fees may also apply which can be around the £700 mark and you’ll often have to cover the cost of a surveyor’s valuation too.
Charges will vary from one provider to another and between advisers, but the total cost of setting up equity release can be as high as £3,000. Many companies offer equity release calculators online, which allow you to calculate how much equity you could release and the cost involved.
It is also a good idea to discuss any plans you have for equity release with family members or beneficiaries in your will to avoid any surprises when the time comes for them to deal with your estate.
» MORE: Other ways to get advice
Alternatives to equity release
Traditional mortgages may offer a cheaper means of releasing cash from your home, although these are subject to age restrictions and older borrowers may struggle. Learn how to get a mortgage later in life.
You could downsize, sell your current home and move to a cheaper alternative, releasing some of the current equity in your home.
» MORE: Alternatives to equity release
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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