Is equity release safe? The 4-minute crucial info guide

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If you have a home, even if you haven’t paid it off fully, and you are looking for something to help with your cash flow situation, then you can access the money that is tied up in your home through a process known as ‘equity release’. Many people have heard the term, but not everyone understands exactly what it means and what is entailed in equity release

Buying a house is obviously expensive, and most people take out mortgages in order to cover this. A mortgage means that you cannot claim to own the home at its full value until you have paid off the whole amount.

The value of what you own, however, i.e. what you have paid off already, is known as your equity.

Equity release is a financial product that is offered by most lenders and it allows you to release some of the money that is tied up in your home. Your home must, however, be valued again, in order for the lender to understand how much you are able to take out. This money, when released, can be issued as a lump sum amount, or you can receive it in many smaller amounts over time. 

Let us explain this with an example. If, for example, you bought a house valued at £200,000, and you paid an initial deposit of 10% which equates to £20,000, you therefore owned £20,000 equity in the home. In a few years, if your home was revalued and had risen in value to £250,000, and in the same time you had paid an additional £10,000 off your mortgage, your total equity would be £80,000.

Normally, the only way you would be able to release this money would be by selling your home and releasing the equity that way. However, you may not want to move home or go through the upheaval of selling. If you are looking for cash to make a home improvement, take a once-in-a-lifetime holiday or consolidate other debts, and you are over the age of 55, but would like to remain in your own home. You are likely to be eligible to release some of the equity another way; through an equity release product.  

Equity release has a great many advantages to those who wish to stay in their own home, and release some of the wealth they have tied up in it.

Types of Equity Release 

There are two main types of equity release product. 

Lifetime mortgage

Lifetime mortgages are the most popular form of equity release. To take advantage of the scheme you need to be over the age of 55. This type of mortgage allows you to borrow a certain percentage of your home’s value at a capped or fixed interest rate.

It differs from a normal mortgage in that you are not permitted to make repayments on a Lifetime Mortgage whilst you are still living in the house; you simply repay the loan amount plus the interest that has accrued on it when the house is sold, either when you move out of it or on your death. As a result of the way this type of mortgage is designed – so that nothing is paid off until the house is sold – the amount owed by you keeps increasing as the interest compounds rapidly, and the total amount that is owed at the end of the period can be many times the original loan amount.

As you can see below, there are some variations of this mortgage offered by a limited number of companies which allow you to repay the interest in monthly or ad hoc payments and in certain cases, the capital as well, but these are the exception to the rule.

Types of Lifetime mortgages

The interest roll-up – On this type of Lifetime Mortgage, you get the lump sum and you then owe interest on the loan which accrues until the loan is repaid. Crucially, you do not make any regular repayments and the interest ‘rolls up’ over time. The amount you owe, which includes the interest as well, becomes payable when the bank sells off your home at the end of the mortgage period.

Interest-paying mortgage – In this case, you get a lump sum amount that you either make monthly or ad-hoc payments on. This can either reduce or stop the impact of the interest rolling up. 

Home reversion plan

With this product, you are given a tax-free lump sum by your lender in exchange for a percentage of the equity in your home. Applicants need to be over the age of 60 to apply. After receiving this amount you are allowed to occupy the property without having to pay rent until your death, or you sell the house. When this happens and the property is sold the lender will retain whatever percentage of the original equity share they bought from you, regardless of the home’s value at the time of the sale. This means that if the home has risen significantly in value since the plan was taken out the amount the lender takes will also rise significantly.

For instance, if the equity in your property is valued at £200,000 and you decide to sell a 40 percent share in it, you may receive a lump sum of £40,000. There is a big disparity between the value of your house and the amount that you receive, but the provider has to carry the risk that your home may fall in value, that they have to cap the interest they can charge you, and that there is a ‘no negative equity’ rule they must abide by. This makes the product expensive. Assuming that after many years, when you die, the value of your property rises to £300,000. The provider will be entitled to 40 percent of the proceeds which would come to £120,000.

It should also be noted that the amount you will be offered for a percentage ownership of your house will generally be below the market value of your property.  

Is equity release safe?

In order to come to a decision about whether you think equity release is safe, you must consider the following benefits and risks of the products.

Benefits of equity release

It is regulated

Equity release is regulated by the Financial Conduct Authority (FCA). For additional protection, it is regulated by a body known as the Equity Release Council (ERC) which represents the qualified advisers, the equity providers, and all the surveyors who work within the equity industry. All of these people must adhere to a strict code of conduct which is all geared towards safeguarding you as the customer.

As the ERC says, “equity release is one of the most regulated financial products in the UK.”

Equity release ensures that you never leave your family in debt

As part of the regulations governing equity release products, there is a ‘no negative equity’ guarantee which covers all products.  This means that should the value of your home not rise in line with expectations, or it should fall, then you (or your family in the case of the house being a part of your estate upon death) will never be left with a debt amount to repay that is greater than the value left in your home at the time of the sale.   

Equity release ensures that you retain your home

With equity release, you get to stay in your home whilst also freeing up cash to do those things in life you want, or need to do. 

With a traditional mortgage the main risk for borrowers is that your may find yourself unable to make  repayments and that if you get too far into debt the lender may decide to go to court to get an order to repossess the property.  The lender will then sell the property to recoup as much as possible of the money which it had lent to the borrower.  With most equity release schemes however, you the borrower are not required to make any regular repayments to the lender, so the question of not being able to afford to repay the loan simply does not really apply. 

It is rare for a lender to take possession under an equity release plan but as with every contract, failing to comply with the terms and conditions of an equity release plan, could mean that your house might be repossessed.

Your monthly outgoings won’t increase

Under most equity release schemes, you won’t repay the money unlocked by equity release or the interest on it until you move into long-term care or die. Up until that point your equity release plan won’t cost you anything, aside from initial set up fees. 

You can use the money however you like

You can choose to spend your windfall however you like. It could be for essential home improvements, or adaptations. Maybe to help family members out financially or simply to be able to live out your years in comfort and be able to afford to do the things you’ve always dreamed of. It’s your money to choose what to do with.  

You are free to move into another house

Most equity release providers will allow you to move to another home subject to them approving the transfer of the loan to the new property. 

You can take the money as and when you need it

Unlike other types of loan you don’t need to take all your money in one go. It is possible to take it in smaller sums as and when you need it. There are advantages to this as it means you are not paying interest on any equity you’ve not yet released, but you retain the right to use it should the need arise. 

Risks of equity release

You diminish a pot of money you may have wanted to ring-fence for inheritance / care fees

Equity release is arranged on the proviso that the borrowed sum of money, plus any interest accrued up to the capped limit, will be repaid when the house is sold. This is usually when you move into long-term care, or when you die.

If the amount that is owing is very large – which it certainly can be once you factor in the interest rates and fees that are due on top of the borrowed amount – there might be nothing, or very little remaining to either pay for care home fees or to pass on as inheritance.

If you are able to pay back some of the interest whilst you are still in the house you will be able to keep more of your homes equity for yourself, but if you are not able to afford to do this you risk there being far less in the pot once the house is sold than you might ideally have liked. 

Interest can quickly mount up

The longer the time period between you taking out the equity release plan, and the loan being repaid, the greater the amount of interest that is going to be owing at the end. Whilst there is a cap on the total amount of interest that is allowed to be charged under these schemes, it can still wipe out all of the remaining equity in your home and mean that you, or your family, are left with an unpleasant surprise when the property comes to be sold. 

You could miss out on the benefits of house price rises

If you have a type of plan where the lender owns a set proportion of your house, then if house prices rise considerably, then so does the lender’s take at the point of sale. 20% of the valuation price on your house at the time of taking out the plan, will convert to 20% of the end sale price, and this could be a far, far larger sum than you were originally loaned. 

Conclusion

In summary, equity release has a great many advantages to those who wish to stay in their own home, and release some of the wealth they have tied up in it. There are no monthly repayments to worry about and you therefore cannot be thrown out of your home for failing to keep up with payments. However, it comes at a price as the amount the lender can end up taking when your house is eventually sold, can be very high. If this is something you are not concerned about as you would rather spend the money now, or your need is greater now, then equity release is a good choice. However, if you worry about the potential future implications of this, then it is best to look into alternatives to equity release

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