Equity release schemes allow you to release some of the money tied up in your property, while you continue to occupy it. This money can be used to fund your long term care, or help boost your income in retirement. However, equity release is not suitable for everyone and can be risky so you should take financial advice if you're not sure.
There are two main types of equity release scheme: lifetime mortgages and home reversion schemes.
With a lifetime mortgage, you borrow a proportion of your home’s value to release a lump sum. Interest is added to what you borrow but nothing is repaid until you die or sell your home. Lifetime mortgages are available after the age of 55.
How do lifetime mortgages work?
If you take out a conventional repayment mortgage, interest is charged on a decreasing amount of debt, because you make payments to reduce the size of the mortgage over time. With a lifetime mortgage, you don’t make repayments during the life of the loan. This means that the interest is ‘rolled up’ during the period of the loan, and charged on an increasing amount. Because of this your debt can grow very quickly – but providers who are members of the Equity Release Council (ERC) guarantee that you will never have to repay more than the value of your home. Most lifetime mortgages have a fixed interest rate.
Different types of lifetime mortgage
There are four main types of lifetime mortgage, suited to different needs and circumstances:
- Lump-sum: this is the basic form of a lifetime mortgage. You take out a lump-sum loan where the interest is rolled up over the term, with rates usually fixed at the outset. You don’t have to repay anything while you’re still alive.
- Drawdown: this is a flexible lifetime mortgage. You take out a smaller amount at the outset, and draw down further borrowings as required. Because you only pay interest on what you have borrowed, the overall cost can be cheaper than with a lump-sum plan.
- Interest repayment: some providers allow borrowers to reduce the cost of a lifetime mortgage by repaying some or all of the interest during the life of the loan.
- Enhanced: some providers also offer more money and better rates to borrowers with health conditions that give them a lower-than-average life expectancy.
Disadvantages of a lifetime mortgage
Although lifetime mortgages may seem like an attractive option, there are some potential downsides to bear in mind:
- The cost of a lifetime mortgage can be high. In some cases, you could drain almost the entire value of your home, leaving little behind when you move out or die.
- Early repayment penalties: most providers don’t allow you to pay off the loan, and if you decide to end the deal prematurely, providers can demand a large early repayment charge.
- Difficulties moving: although members of the ERC allow you to move your plan to another property, in practice this can be difficult if the new property is worth more than the equity remaining in your old one.
- Means tested benefits: generating extra cash through equity release could mean that your entitlement to pension credit and council tax benefit is affected.
Home Reversion Schemes
These schemes usually involve you selling a share of your home to a provider for less than the market value. You have the right to stay in your home for the rest of your life, and when you die or move into long-term care and your property is sold, the provider gets the same share as the amount they bought at the beginning. For example, if you sold 50% of your home to a home reversion provider, the provider would get 50% of the sale price when you die or leave the property.
Unlike lifetime mortgages, which are available from the age of 55, home reversion schemes are only offered to people aged 65 and over. Providers demand a bigger share of the property from younger borrowers, and less from older ones. Some companies also offer enhanced products for those with a lower-than-average life expectancy.
It is important to note that the cost of a home reversion scheme can be harder to estimate than the cost of a lifetime mortgage, as the overall cost is based on the sale price of your home at the end of the deal.
Alternatives to equity release
If you're facing a pension shortfall, there may be other options available to you:
- Downsizing: selling your current property and moving to a smaller, cheaper home could free up a lump sum to boost your pension pot.
- Rent out a room: you can earn up to £4,250 a year tax-free from renting out a room in your home.
- Delay taking your state pension: for every five weeks that you delay claiming, you'll receive an extra 1% – that's 10.4% for every full year you wait to claim.
- Delay retirement: take a little extra time to build up your pension pot
When making significant financial decisions you may wish to seek the help of a financial adviser, who can give you expert advice tailored to your circumstances.
Last updated: 12 June 2015