Is equity release a sweet release?

• Struggling for cash or just want a more comfortable retirement?

• If you own your own home, equity release could be an easy solution. According to the adverts at least.

• But, as with a lot of things in life, it’s not as straightforward as it seems.

The TV ads might suggest the biggest market for equity release are retired baby boomers, but this is not necessarily the case. A report by the FCA on intergenerational wealth found that it is Generation X (those born after 1965) rather than today’s retirees (the baby boomers) who are most likely to need help [1].

This is the squeezed middle: middle class, middle income and middle aged. They are also the middle generation trying to fund tuition and/or university fees for their kids whilst meeting the demands of later-life care for their parents. On top of this they are facing their own retirement saving challenges.

Read more: An education in school fees

What is equity release?

Equity release is the general term for a number of strategies that allow you to access the equity tied up in your home. You can take the money as a lump sum, as a series of smaller amounts, or as a combination of both. But like a mortgage, at some point the company providing you with the cash or income must be repaid, usually when you die or move into long-term care.

• If you do not have any heirs then equity release could be a decent, though expensive, route to raise cash.

• But if you had intended to leave an inheritance for your children or grandchildren, then equity release could mean there will be less for them to inherit. And maybe even nothing.

How does it work?

In the UK there are two types of equity release plan. The most common form is a lifetime mortgage; one that isn't paid off until you die. In the meantime you retain ownership of the property but the company holds a charge over it. Much like a traditional loan or mortgage. You can usually access these plans from the age of 55

The other type of plan is a home reversion plan. You sell all or part of your property to the equity release provider in return for a right to remain there rent free. You can usually access these plans from the age of 60 or 65.

In either case your property must be in reasonable condition and over a certain value, and there may also be restrictions on the type of property the company providing the funding will accept. During the life of the loan, you retain the responsibilities and costs of ownership, including making sure the property is maintained to preserve its value. And there are limits on the amount that you can borrow: around 60% of your property’s value [2].

Lifetime mortgage

In a traditional mortgage arrangement you pay interest on the amount borrowed from your income and you can still do this if your purpose was to release a lump-sum amount for a specific purpose. But if the whole point of borrowing the money is to supplement your income you can elect to have the interest on the loan added to the value borrowed, which rolls up over your lifetime.

If you had a mortgage in the 1980s when interest rates were much higher than they are now you will be familiar with this type of arrangement. But the lesson from history is that the charges can soon mount up.

If you are being charged 5% interest on a £100,000 loan, you might think that this simply means the loan amount increases by £5,000 each year. But you’d be wrong.

At the end of the first year your loan has indeed increased to £105,000. But this means at the end of year two the interest owed increases to £5,250: 5% on the original £100,000 and 5% on the additional £5,000. This is again added to the amount borrowed and the outstanding value increases to £110,250. The amount of interest in year three rises to 5,512.50.

At this rate the amount borrowed will double every 14½ years [3]. Increasing life spans mean many of us can expect to live to our mid eighties [4]. If you started borrowing when you were 55, this could mean 30 years’ of rolled up interest, leading to a total liability of £432,194.

This is the type of scheme that garners most of the shock headlines when children discover their family home will realise a lot less than they had expected.

Home reversion

Here a provider pays you a tax-free lump sum to buy a fixed portion of your home. You can then live in the property rent-free until you die. When it's sold, the proceeds are split based on the percentage you own and what the lender owns. It’s similar to a shared ownership scheme. If your property value rises significantly, so does the amount the lender receives.

The percentage you retain will always remain the same regardless of the change in property values, unless you decide to take further cash releases. But it allows you to ring-fence a percentage of the value of your property, possibly to leave as an inheritance or for care home fees.

The amount you get will depend on several factors such as your age and your health but will generally be between 20% and 60% of the market value you could have achieved if you had decided to sell up and downsize [2].

Equity release is not without its risks.

If you take out a lifetime mortgage you will normally be charged a higher rate of interest than you would on an ordinary mortgage. You'll have to pay arrangement fees, legal work and surveyor fees. And as we have seen your family could end up with little or nothing to inherit from your property. The lender could also insist on the house being sold through an agent to maximise the amount recovered.

Home reversion plans will usually not give you anything near the true market value of your home compared to selling your property on the open market. You might not be able to rely on your property for money you need later in your retirement. For long-term care, say.

Although you can move home and take your lifetime mortgage with you, if you want to downsize you might not have enough equity in your home to do this. You will be responsible for paying all the costs of the sale, including solicitors’ fees; and some providers might levy an administration fee for removing their charge against the property.

There might also be early repayment charges if you decide to sell your house to move in with a relative rather than move into long-term care.

Finally the money you receive from equity release might affect your entitlement to means-tested state benefits such as Pension Credit, Jobseeker’s Allowance, Income Support, Income-related Employment and Support Allowance, Universal Credit, and Council Tax Support.

What happens to my partner if I die?

If your plan is in joint names, then your partner will be able to continue living in the property under the same terms. If it is in your name only, then unless the mortgage can be repaid in full the property will have to be sold and your partner will have to find somewhere else to live.

If you marry after you have taken out a plan, or if someone comes to live with you as your partner, then you must tell your lender. It may not be possible to add them to your plan, in which case they will not necessarily have the right to continue living in the property if you die or move into long term care.

The same goes if you have any children or other relative living at home. They might have to sign a waiver confirming they will move out as soon as you are no longer living at the property.

Conclusion

When releasing equity, it’s tempting to focus on the immediate boost you will get from the money you unlock, but you need to look at how it will affect your future choices and financial situation in later life.

There are currently more than 400 different schemes from which to choose [5] and they can be complicated to unravel if you change your mind. Talking to a fully qualified financial adviser could help you understand what’s involved, the options available, and how it might affect your state benefits and tax position.

They might also uncover alternative ways of meeting your needs including a traditional mortgage, selling some of your other assets or even downsizing. A smaller home could require less upkeep and might be able to meet your longer-term needs, such as fewer stairs. But even this could incur agency and solicitor’s fees and removal costs .

Sources:

[1] Intergenerational Differences, Discussion document DP19/2, Financial Conduct Authority, May 2019

[2] Money Advice Service https://www.moneyadviceservice.org.uk/en/articles/equity-release, correct as at 27 December 2017

[3] Schroders Personal Wealth

[4] Office for National Statistics. https://www.ons.gov.uk/peoplepopulationandcommunity/birthsdeathsandmarriages/lifeexpectancies/articles/whatareyourchancesoflivingto100/2016-01-14

[5] https://www.equityreleasecouncil.com/news/autumn-market-report-2019-press-release/

This article is for information only. Equity release is not offered by Schroders Personal Wealth. It is a complex area and we recommend you weigh up all the positives and negatives, and take professional advice before committing to a course of action. Lending is subject to an assessment of your circumstances. YOUR HOME IS AT RISK IF YOU DO NOT KEEP UP REPAYMENTS ON YOUR MORTGAGE.