The pitfalls of equity release. Is it safe for me?

Four old village houses in a row with a countryside view

Equity refers to the proportion of your property that is owned outright by you and which isn’t still being repaid on a mortgage. 

There are two ways you can increase the equity in your home; if the value of your home goes up, and if you pay down your mortgage debt through a repayment mortgage. 

Homeowners sometimes wish to borrow against their equity for things like home improvements which can add value to their home, or to pay for important things which require a large lump amount of money. In these circumstances, it’s not uncommon for homeowners to look at equity release products. 

Equity release products can present a good opportunity with few potential dangers.

What is Equity Release?

The most obvious way to access your equity is by selling your home. If you downsize or relocate and move into a lower value home, then you will have freed up your equity into cash. However, not everyone wants to, or is able to move home. This is where equity release products come in. 

The term equity release refers to a range of products that let you access the cash – otherwise known as the equity – tied up in your home, but crucially, without the need to move home. 

You can apply for equity release when you are still paying a mortgage or when you have finished repayments, but you must own a part of the home outright. The money that is released can be given to you as a lump sum or in several smaller instalments. 

To be eligible for an equity release product, you must be aged over 55, you must own your own home or have a small mortgage on it, and your home must meet the criteria the lenders place upon it.

Why do People Choose Equity Release? 

There are several benefits to equity release which have meant they have become popular products in recent years. Those benefits include;

  • No repayments to worry about as equity release products and the interest charged on them, are only paid back once the house is sold, usually when the homeowner moves into care, moves in with a family member, or dies.
  • You get to keep your home. No need to sell or move out in order to access the cash tied up in it.
  • Relatively low interest rates when compared to some other forms of lending, and the interest rates are usually fixed for the life of the loan.
  • A way of accessing money to do those things in life you don’t want to put off.
  • A ‘no negative equity’ guarantee meaning that you have protection from ending up owing more money than the value of your property.
  • It can be a way of avoiding paying Inheritance Tax 
  • Equity release products are well regulated by the Financial Conduct Authority and the Equity Release Council.

The Pitfalls of Equity Release

However, despite the many benefits that equity release products can have for those people who wish to take advantage of a cash lump sum payout without having to move from their home, there are also many dangers attached to the schemes which mean they are not always suitable for everybody.

The interest can mount up quickly

Equity release can be expensive when compared to ordinary mortgages as you will be paying a higher rate of interest and the debt can grow very quickly if interest is rolled up. Because lenders have to factor in things like the ‘no negative equity’ rule, the fixed interest rate cap, and the fact that there are no guarantees that house prices will continue to rise. This means that equity release is a very expensive product. 

Interest on equity release loans can mount up very quickly, and if you live for a long time after taking out the plan, your total debt could eventually match the total value of your home. (It cannot exceed it as under rules laid down by the Equity Release Council, lenders must have a ‘no negative equity’ promise.) If you take out the most commonly sold type of equity release product, known as a Lifetime Mortgage, interest is added and ‘rolled up’ for the entire life of the plan, until you move out of the house, or die. This can substantially increase the amount of debt that is owed at the end of the plan, leaving you with very little equity at all in the property.

Lost equity means it cannot be used for care costs or inheritance

If you plan on leaving your home to beneficiaries in your will as a part of your estate, or if you had planned on using your home’s equity to pay for care costs in old age, then you should think very carefully before taking out an equity release product as you may not be left with much equity by the end of the life of the product.

With another type of equity release plan, the Home Reversion plan, you sell a share in your home to a lender in return for a cash lump sum and the right to remain living there. When the property is eventually sold, the provider gets that same percentage share of the proceeds.

The danger to this however, is that if house prices rise, you or your family do not benefit from all of the house price rise if your home is left to them in your will. If the lender bought a 40% share in your home, they will be entitled to a 40% return when the house is sold, even if this is many times the original price they paid for that share.

Limits on how much you can release

There are limits on the amount you can release, even if you have a considerable amount of equity in your home. As a rule of thumb, the younger you are and the better health you are in, the less equity you are able to unlock. The average amount loaned by UK lenders is around 35% of a home’s equity, with the maximum usually being 50%. It’s important not to forget that interest charged over the term of the loan can significantly eat into the remaining equity.

Your home might not meet the lender’s criteria

Your home must meet the strict criteria of the lender before being accepted onto one of the equity release schemes. You are bound to keep it well-maintained and well-kept. The minimum property value any lender will accept is £70,000. In addition, they will want to see that you are capable of keeping your home in good condition.

Early repayment penalties can be high

With equity release products, if you decide to abandon the plan earlier than you originally intended, the repayment penalties can be high.

Lost entitlement to state benefits

By taking out one of these products, you may lose entitlement to certain means-tested benefits. 

If you receive any means-tested benefits, they may be reduced or lost entirely. Means-tested benefits include; Pension Credit, Jobseeker’s Allowance, Income Support, Income-Related Employment and Support Allowance, Universal Credit and Council Tax support. 

It may not be suitable if you have dependents living with you

Equity release products may not be suitable if you have dependents still living with you. They would need to sign a waiver confirming that they understand they do not have a right to continue living in the property after you move out of the property or die. 

So, is it safe?

This is a difficult question to answer as so much depends on your personal circumstances and your priorities. If you have no family to think of in terms of inheritance, or you feel that the equity in your home is something you worked hard for and should be enjoyed now while you still have the chance, and you do not wish to downsize or relocate, then yes, equity release products can present a good opportunity with few potential dangers. Thanks to the ‘no negative equity’ clause and the fact that there are no monthly repayments to worry about not being able to meet, you cannot be thrown out of your own home for non-payment of the loan and you cannot end up owing more than you borrowed.

However, the interest charges on equity release products can become very large over time and result in the equity you did have in your home, being quickly swallowed up. This means that if you had plans for that equity – whether it was to pay for long-term care, or to spend on something else further down the line, or to give in inheritance to your family – there may not be anything left at the end of the mortgage for those plans.

In all cases, it is a good idea to look at alternatives to equity release and assess all options before making a decision. Some people decide that downsizing is a better option for them, or asking family members to help with a loan instead.

Conclusion

As much as releasing the equity locked in your home can seem beneficial, it can also be a complicated and expensive process that isn’t right for everyone. Whatever your decision, it is essential that you speak to an impartial and experienced advisor before signing up to anything. 

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