What is Equity Release?
Most people find that their home is the most valuable asset they own. However, owning a property is not an easy task. Houses don’t come cheap! Often, homeowners have had to save up to buy the property, such as raising the deposit, and meeting the conveyancing fees and removal costs. They’ve had to pay the mortgage throughout as well as maintain the property and insure it. As a result, they often find it hard to build up savings for other things so that by the time retirement comes around, people find that they need access to cash that they don’t have.
If you don’t have enough savings, there are ways to use the value of your home to boost your finances. One way is to sell the property, and downsize, or you can take in lodgers. Another way, if you want to continue to live in the property for as long as you wish to and don’t want to have to share with other people is to go for Equity Release. Essentially, Equity Release is a way of extracting cash out of the property by taking out a loan secured on your home. The homeowner may then use the released money for any purpose, such as clearing debts, carrying out home improvements, or boosting retirement income. However, equity release can be quite expensive, and may mean that there is not much equity left in the property for your family to inherit when you pass away. It is therefore vital you understand the mechanics of what equity release entails, before you decide to commit.
Equity Release Schemes, unlike sale-and-rent-back schemes, which are aimed at financially distressed homeowners of any age and are less suitable for older clients, are only available to individuals aged over 55, who own property in the UK with a minimum value of £70,000.
Types of Equity Release Schemes
There are two broad types of Equity Release Schemes – Home reversion Plans and Lifetime Mortgages.
With Home Reversion Schemes, an equity release company buys a share, or all, of the property from the homeowner, whilst allowing them to retain the right to carry on living there, and in the meantime, waits for the value of that share to increase. However, it is important to remember that because it won’t have access to the money until the property is actually sold, the amount the equity release company will actually offer to the homeowner will be significantly below the actual value of the shares.
In contrast, Lifetime Mortgages are far more common than Home Reversion Schemes. With these, the loan comes with a fixed interest rate but, unlike conventional mortgages, it doesn’t have to be paid off in regular instalments. Instead, the debt is rolled up, which means that the interest is calculated on an increasing total and only repaid at the point of sale. The benefit of using a Lifetime Mortgage is that the lenders will provide a guarantee against ‘negative equity’. Put simply, the homeowner will never owe more than the value of their home. Whilst some companies may let homeowners pay off part of the interest as they go, if the homeowner decide to keep the loan until they pass away, they could risk having a chunk of the sale proceeds getting snapped up, which means that there won’t be much left to pass on to their family members.
Is it right for me?
Whilst Equity Release Schemes can be a great way of getting your hands on some cash, they are not for everyone. Not only are they a rather expensive way of obtaining equity, it is also very costly to switch to other plans at a later stage. Lenders can charge penalties of up to 25% if you decide to repay the loan early.
The first question that you should always ask yourself, before considering an Equity Release Scheme, is whether you are in a position to sell the house you own now and move to a smaller property, as this is likely to be the most straight forward and cost effective way of securing finances.
If you then decide that Equity Release is an option that you would like to consider, it is crucial that you consult an experienced Independent Financial Advisor (IFA). Schemes tend to contain complex restrictive clauses, so it is vital that you understand them before entering into legally binding agreements.
Considering Equity Release
If you do decide to proceed with an Equity Release Scheme, it is important for you to remember that doing so might affect your state benefits, although this is not always the case. Essentially, any cash that you receive from equity release will reduce your estate. This means that, as a result, there is bound to be less money available to be left to your beneficiaries.
When considering Equity Release Schemes, it is important to be clear about the advantages and disadvantages that such plans may bring with them.
Advantages of Equity Release Schemes
- Homeowners can continue to live in their own homes for the remainder of their life or until such time as they move into a permanent care home. This covers both partners if they are living together.
- Most Schemes are flexible enough to allow homeowners to choose whether to release equity as a lump sum or a lump sum with a drawdown facility.
- The ‘no-negative equity guarantee’ means that homeowners will never risk having to pay back more than the value of their house and that their estate will never owe more than what the property is worth at the point of sale.
- The equity released will be tax-free and can be used for anything homeowners like, from repaying debts and carrying out home improvements to boosting retirement income.
Disadvantages of Equity Release Schemes
- The value of the homeowners’ estate will reduce and, therefore, the amount they will be able to pass on to their beneficiaries in inheritance will also decrease. Similarly, their entitlement to state benefits can be affected.
- If homeowners decide to repay or end the scheme that they have in place early, there are likely to be high financial penalties for doing so.
- Some lifetime mortgages have to be repaid with compound interest, which means that long-term the amount they owe can accumulate quite rapidly.
- Equity Release is just one option for acquiring equity from residential property. An example of a simpler alternative can be downsizing to a smaller house.
Minimising Risks associated these Schemes
Equity Release is governed by the government body – the Financial Conduct Authority. Homeowners have the option to check that their advisors are authorised by the FCA on the regulatory body’s website.
Another way of minimising risk is by dealing with scheme providers, who are members of the Safe Home Income Plans (SHIP), which is a trade body set up by providers of equity release schemes, which has its own code of conduct. This code of conduct is actually much tighter and more stringent than that of the FCA. Members of SHIP usually insist that homeowners appoint their own independent solicitors to advise them on the terms and conditions of the loan before they agree to the release of any equity from their property.
It is also prudent for homeowners, who have an existing lifetime mortgage, to check and see whether it’s worthwhile for them to switch over to a new plan. As mentioned above, switching from one plan to another is not always the most financially viable decision but, on the other hand, depending on the homeowners’ particular circumstance, this can save thousands of pounds by swapping to a more up-to-date plan.
Disclaimer – our articles are designed to give you guidance and information. There is no substitute for proper direct advice, particularly as everyone’s circumstances are different. If anything in this article may affect you, please contact us for advice that is specific to your circumstances.