Have you heard about equity release but aren’t really sure how it works or whether it is right for you?
Do you have vague memories of equity release horror stories from years ago and fear that you may be ripped off?
Let’s take a closer look at what equity release is, whether it is right for you, and how you can avoid being the main character in a horror story!
1. How Does Equity Release Work in the UK?
Well, before we consider how equity release works in the UK we should, first of all, understand exactly what we mean by the term equity release:
1.1 What is Equity Release?
When we buy a house the majority of us will do so by taking out a mortgage.
The mortgage provider secures this monetary advance by taking a charge over the house.
In simple terms, this means that if the house is sold the mortgage provider has the first call on the sale proceeds.
And we get whatever is leftover. This is known as the equity in the house.
For example, if the value of our house is £250,000 and the outstanding mortgage is £150,000 (60%) this leaves equity of £100,000 (40%).
OK, so if that’s the ‘equity’ part, what is the ‘equity release’ part?
Equity release is an arrangement that enables you to obtain money from the equity in your home without you having to move out.
1.2 How Does Equity Release Work in the UK?
There are 2 main products that are used for equity release:
- Lifetime Mortgage
- Home Reversion Plan
Let’s take a closer look at the key features of each.
1.3 Lifetime Mortgage
- Suitable for those aged 55+
- The most popular form of equity release
- Cash/equity received is secured on the value of the house as with a normal mortgage
- Mortgage repayments are not required
- Funds can be taken as one lump sum or as a series of smaller amounts as needed (known as drawdown)
- The mortgage has a fixed rate of interest charged on the money taken
- The interest will compound (roll-up) over time unless repayments are made (when receiving interest or dividends, compounding returns are a marvellous thing – when paying interest, it is punishing!)
- When the house is sold the proceeds repay the mortgage, including the accrued interest
- Where part of a couple, repayment takes place after the last remaining person has died or has moved into care
- There is a risk that the amount received on the sale of the house is insufficient to repay the mortgage and accrued interest – potentially leaving beneficiaries out of pocket
- Note that if the scheme is from a provider that is a member of the Equity Release Council then a ‘no negative equity guarantee’ must be offered
1.4 Home Reversion Plan
- Suitable for those aged 60+
- The provider pays for ownership of all or some of your home
- The payment will be for less than the market value
- You do not have to pay any rent to the provider for use of their share
- Nor do you have to pay any interest
- When the house is sold the proceeds are split based on the ownership proportions for you and for the provider
1.5 How Much Does Equity Release Cost?
1.5.1 Arrangement Fees
A financial adviser’s fee, often referred to as an arrangement fee or application fee, will typically be around £600.
There is also likely to be a small money transfer fee for transferring funds to your solicitor. This is around £30.
You should be aware that, depending on the adviser that you choose, some advisers also charge an advice fee and a valuation fee. Others include this in their overall cost.
Also, be on your guard for advisers that charge a fee based on a percentage. For example, if you took an equity figure of £100,000 and the applicable percentage was 2% the fee would be a flat £2,000!
1.5.2 Solicitors’ Fees
You will need to appoint a solicitor specialising in equity release to act on your behalf.
Average solicitor fees for handling equity release are around £700-£1,000.
1.5.3 Average Combined Costs
Well-known provider of later life finance, Key, estimates that the average fees for taking out equity release with them are £1,850.
Martin Lewis for Money Saving Expert estimates average costs at between £1,500 and £3,000.
Ultimately, the amount of interest payable will depend on a combination of:
- Funds taken (especially whether one lump sum or by drawdown)
- Interest rate
- Whether interest is compounded
- The length of time before the funds are repaid
Despite working in the accountancy profession, my mental arithmetic sometimes needs some support … from Microsoft Excel!
Let’s look at how to calculate the compound interest:
We know the initial amount borrowed and the rate of interest. The unknown variable, for us and any provider, is how long we will live after receiving the cash – so we’ll have a look at a range.
If we have the initial advance in cell A2, the interest rate in cell B2, and the number of years in cell C2, then the formula for the compounded total debt is =A2*(1+B2/1)^(1*C2).
If you take equity release at 55 then living for another 25, or even 30, years is not, according to the ONS, that unusual.
Little wonder, then, that potential providers will wish to take account of your age when arranging an equity release scheme. Nor that the amounts offered seem so small.
2. The Taxman Cometh … Or Does He?
The funds that you receive from equity release, whichever method you choose, are not subject to Income Tax.
The money is seen as a loan advance rather than a source of income.
Keep in mind that, depending upon the overall value of your estate, Inheritance Tax may require consideration in respect of any gifts that you make to friends and family.
3. Professional Advisers
We’ve all read, or heard, about equity release horror stories, haven’t we?
Well, such horror stories are, thankfully, much rarer these days. Things have moved on and there is a great deal of help and protection available.
3.1 Equity Release Council
The Equity Release Council (ERC) is a trade body that, to quote its About page:
… exists to promote high standards of conduct and practice in the provision of and advice on equity release which have consumer safeguards at its heart.Equity Release Council
Providers that are members of the ERC sell products that adhere to certain standards:
- The rate of interest on lifetime mortgages must either be fixed or, if variable, have a cap which is fixed for the life of the loan
- Customers have the right to remain in the property for life or until they enter long-term care
- Customers have the right to move to another property as long as it is acceptable to the provider as continuing security for the loan advanced
- The product must contain a ‘no negative equity guarantee‘ – ie if the proceeds from the sale of the property are not sufficient to cover all outstanding costs, the shortfall will not create a liability for you or your estate
- All customers taking out new plans must have the right to make penalty-free payments, subject to lending criteria
You should, therefore, ensure that the provider you wish to use is a member of the ERC.
3.2 Financial Conduct Authority
The Financial Conduct Authority (FCA) regulates advisers and providers of both types of equity release plans.
3.3 Financial Advisers
Before you apply for either form of equity release plan you’ll need to discuss your situation with a financial adviser.
This is a requirement of the FCA.
Note that not all financial advisers are able to advise on equity release. You will need one that is qualified in this area.
You may also wish to ensure that the adviser is a member of the ERC.
It is a requirement of the equity release process that you receive independent legal advice from specialist equity release solicitors.
This is because equity release is not solely a financial matter. There are also legal implications and you have legal responsibilities as the property owner.
Your equity release solicitor will:
- Check your identity
- Check your documentation
- Arrange the completion date and fund transfer
You may also wish to ensure that the solicitor is a member of the ERC.
You may wish to speak with your financial adviser in relation to the choice of solicitor. If you have an existing relationship with a firm of solicitors it may be that you want to see whether they are able to act for you in relation to equity release.
4. What Are The Alternatives to Equity Release?
Depending on your circumstances, equity release is not always the only viable option available to you.
4.1 Downsizing Your Property
One of the main alternatives to equity release is to consider downsizing your property.
What does this mean?
Let’s revisit the example scenario from the ‘What is equity release?‘ section. We have a house valued at £250,000, a mortgage of £150,000, and thus equity of £100,000.
What if you were to sell that house and buy one for £175,000, keeping the £150,000 mortgage?
You still have £100,000 of equity.
The difference is that £25,000 is held in the new property (£175,000 value less £150,000 mortgage) and £75,000 is held in cash (£250,000 sale proceeds less £175,000 spent on the new house).
As well as the financial advantage, downsizing also often offers the possibility of finding a property that is more manageable in later life, such as – less house maintenance, less gardening, and swapping a house for a bungalow to avoid stairs.
The main enemy of downsizing is delay!
People often defer downsizing, thinking that they have plenty of time left and that they don’t need to do it yet.
Then, before they know it, they are at the “We’re too old to move now. We should have done it years ago!” stage.
Downsizing can be an attractive alternative to equity release but don’t forget:
- There will be costs involved (estate agents, solicitors, stamp duty etc)
- The move may entail moving away from friends & family
4.2 Use Savings
If you already have savings then the loss of interest on your savings will be far smaller than the interest charged on a Lifetime Mortgage.
If they aren’t set aside for a particular purpose then it may make more sense financially to use these savings rather than use equity release.
4.3 Personal Loan
Depending on how much you need and how long you need it for, it may be considerably cheaper to take out a personal loan rather than an equity release plan.
4.4 External Sources
If you didn’t use equity release, are there family and friends that you would leave your estate to on death?
If so, do any of them have the financial resources, and the inclination, to buy a portion of your house?
Faced with the prospect of an anticipated inheritance being paid out to an equity release provider rather than to them, these individuals may find the proposal to be attractive.
Other external sources, depending on what you want the money for, could be state benefits or local authority grants.
5. Is Equity Release Right For You?
5.1 Financial Outlook
At the time of writing:
- Russia has invaded Ukraine
- The cost of electricity and gas is spiralling out of control
- Inflation is at 10.1% and expected to go higher
- Multiple groups of workers are striking for better pay
All in all, I think it’s fair to say that we are in a period of financial uncertainty the likes of which have not been seen for decades.
This is combined with the fact that house prices have seen substantial growth in recent years and we have historically low rates of interest (despite the Bank of England’s recent rate rise).
It may not surprise you to hear, therefore, that sales of equity release plans are at record highs.
5.2 Use of Released Funds
So, what do you plan to use the money for?
We’re all different and all have different wants and desires. Typical uses include:
- Once-in-a-lifetime holiday
- Home improvements
- Helping with family costs (deposit for first-time buyers, education fees etc)
- Long-term care costs
- Paying off debts
If it is the latter item that is motivating you then do consider what other options may be available.
At the very least it is probably worth a chat with:
5.3 Equity Release Tips
Equity release is not something that should be entered into without giving it the consideration that it deserves. A certain candidate for “Act in haste, repent at leisure.“
That being the case, here is a list of things to consider before you proceed:
Don’t be tempted to make secret arrangements for equity release. That is a recipe for potential disaster. Be open – discuss things with family and friends. There are few things better at causing family rifts than money!
Taking out equity release will reduce, and possibly eliminate, any funds available for inheritance. There is nothing wrong with this – it is your money after all – but do be aware of the consequences.
Keep in mind that the receipt of equity release funds could have a detrimental impact on your ability to claim certain means-tested benefits. This is especially so in relation to the payment of care home costs. Others include: pension credit, universal credit, jobseeker’s allowance, income support, and council tax support.
Check that your financial adviser is registered with the FCA.
And that they are members of the ERC.
Check whether the adviser is independent (an IFA) and able to check the whole of the market for suitable products or whether they are tied to a particular provider.
Get a written quote for all fees.
- Release me!
Find out what the early repayment charges are if you change your mind and wish to repay the lifetime mortgage. They can be very high.
- Negative equity
Even if they are with the ERC, double-check that any agreement contains a clause ensuring that there can be no scenario where there is negative equity.
- Pace yourself!
You don’t have to borrow the whole amount all at once – you can take it in instalments. Doing so will reduce the impact of compounding interest that we referred to earlier.
How old do I need to be for equity release?
It depends on which type of equity release arrangement you are considering. For a Lifetime Mortgage arrangement, you must be aged 55 or over. For a Home Reversion Plan arrangement, you must be at least 60 years old. In each case, if taking out a plan with a partner it is the age of the youngest borrower that is important.
How long does equity release take?
This will vary due to the different combinations of advisers and providers in any particular equity release scenario. That said, the process should normally be finished within 8-12 weeks.
How do I repay an equity release mortgage?
The loan, referred to as a Lifetime Mortgage, is usually repaid from the proceeds of the sale of your home, either when you die or when you go into long-term care.
Can I still provide an inheritance after taking equity release?
Yes, you can.
There are policies which permit you to secure a proportion of the proceeds from the sale of your home for the beneficiaries of your estate (obviously this will reduce the amount that you can take).
Or you could simply make a gift, during your lifetime, of the chosen amount out of the loan that you receive. Keep in mind that, depending on your circumstances, this may have implications for Inheritance Tax.
How much can I borrow from equity release?
It won’t surprise you to hear that … it depends!
With a lifetime mortgage, equity release providers will primarily look at the value of the property and your age. All other things being equal, an 80-year-old is likely to be able to borrow more than a 55-year-old, simply because there is likely to be less time for interest to accrue. As a ballpark figure, something like 50% is likely.
With a home reversion plan, you may be able to sell the whole of your property. The amount received will be discounted down from the true market value – the younger you are, the higher the reduction will be.
Hopefully, you now know the answer to the question “How does equity release work in the UK?“.
If equity release is something that you feel is right for you then I suggest that you start by having a discussion with friends and family – the more knowledge that you have on the topic, the easier it will be to make the right decision for you.
If you have already used an equity release arrangement I’d love to get your feedback in the Comments below.