Guide to Equity Release

 

 

 

What is equity release?

Equity is the term given to the difference between the mortgage on your house and how much it’s worth. So, if your home is worth £200,000 and you have a mortgage of £150,000, you would have £50,000 worth of equity. Releasing this equity can be achieved in a number of ways. When you are earning and still have a mortgage, you can take a ‘further advance’ from the lender, which means ‘upping’ the loan against the current value of the house. Many homeowners choose to take a further advance at the same time as they remortgage to a different lender or to a different deal with the same lender. Equity release schemes

This constitutes ‘releasing equity,’ but slightly confusingly, ‘equity release’ is a different thing altogether. Equity release schemes are aimed typically at retired homeowners who find themselves with little disposable income, but living in a property which may be worth hundreds of thousands of pounds.

Council of Mortgage Lenders (CML) figures show that retired homeowners collectively are sitting £1.1 trillion of unmortgaged equity in their homes.

Under an equity release scheme, homeowners are able to release a proportion of their property in return for a cash lump sum, an income for life or combination of the two.

There are many reasons why people may take out an equity release plan and some of the more common reasons are:

  • To supplement inadequate pension income
  • To fund aspirational desires (home improvement, car, holidays etc)
  • Debt consolidation
  • To meet care needs
  • To financially assist children/grandchildren
  • Inheritance Tax Planning

There are two principal types of equity release scheme:

  • home reversions and
  • lifetime mortgages

With a Home Reversion Plan, you sell all, or a percentage, of your home to a home reversion company in return for a lump sum, an income for life or a combination of the two.

Crucially, if you continue to own the portion of the property you have not sold which means that your estate will benefit from any uplift in the value of this portion of the property when you die. If you have sold all of your home you will no longer own the home and will not benefit from any future increase in its value.

You can continue to live in the property paying a peppercorn rent until you die or until you have to sell the house to go into a nursing home.

By contrast with a lifetime mortgage, you take out an interest only mortgage against the value of the equity in your property. With the majority of lifetime mortgages you do not have to pay any interest on the mortgage during your lifetime as this is ‘rolled up’ – or added to the mortgage capital, with the whole debt paid off, when you go into long term care or die, from the proceeds of the sale of the property. An interest rate of 7% would see the amount owing on a rolled up interest lifetime mortgage double in just over ten years.

Most equity release providers are members of Safe Home Income Plans (SHIP). These providers give their customers a ‘no negative equity guarantee’ which means you not have your home repossessed if the debt on your property (the capital, plus interest) exceeds the property’s value. SHIP members also have to adhere to other criteria which are designed for the benefit of the consumer.

Both home reversions and lifetime mortgages can be taken out on a joint basis so that if one partner dies or goes into care, the other partner has the right to remain in the property.

Today, there are over 100 equity release plans on the market offered by almost 30 providers. Qualifying criteria vary across the providers but typical requirements are as follows:

  • you own a home outright (ie with no mortgage or with a mortgage that will be cleared by the equity release) that is worth a minimum of £40,000 to £100,000 for lifetime mortgages, or at least £60,000 to £80,000 for home reversions.
  • you (and your partner/spouse) are aged at least 65 for home reversions or about 60 for lifetime mortgages.
  • you own a freehold property, or one with a minimum unexpired lease of at least 75 to 90 years
  • the property is constructed from conventional bricks and mortar and is in good repair
  • there are no tenants living in the property

You should also explore the alternatives to equity release?

Prior to making any decision it is important to explore all the possible alternatives.

Equity release is, by its nature, a long term product and, once taken out, it may prove expensive, or very difficult, to exit.

Clearly individual circumstances will vary but some of the possible alternatives may include one or more of the following:

  • check that you are receiving all the state benefits to which you are entitled
  • downsize (sell your property and buy a cheaper property)
  • sell your property and rent instead
  • delay your retirement or take a part time job
  • a grant may be available from the Home Improvement Agency or your local council
  • move in with relatives or friends
  • rent out a room to a lodger
  • use some of your other assets
  • infilling property development
  • get financial help from a relative or friend

This list is not exhaustive and each will have advantages and disadvantages which you will need to consider. Your adviser should be able to help you do this.

WARNING!‘Sale and rent back’ or ‘sale and lease back’ schemes are also promoted. These schemes are not the same as equity release and are not currently regulated. If you are contemplating taking out one of these schemes you are strongly advised to take out independent advice. One of the areas that you should particularly check is your security of tenure.

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How do the different kinds of equity release schemes work?

Lifetime mortgages

With a lifetime mortgage, you raise a mortgage against the equity in your property, with the size of the mortgage you can raise being dependent on your life expectancy which can be gauged according to your age, sex and state of health.

To put it bluntly, the older you are and the worse your state of health at the outset, the higher the percentage of the property’s value you can borrow because the lender expects to get its money back sooner.

For instance, a 60 year old might get a 100% rolled up interest lifetime mortgage equivalent to about 20 per cent of property value, whereas a 90 year old would normally qualify for the about 50 per cent of property value.

The costs involved with a lifetime mortgage are the valuation which is required to obtain an independent assessment of the value of your property. (See the charges section for more on this). There will also be solicitor’s fees and sometimes a mortgage arrangement fee.

The mortgage (capital and interest) will be paid off from the sale of your property, when you die, move home or go into a nursing home. The equity release company will normally insist that the house is sold within one year of any of these events taking place.

Lifetime mortgages have been regulated by the Financial Services Authority since October 2004.

How is interest charged?

The majority of lifetime mortgages are fixed rate, interest only mortgages. This means the interest rate you pay on the mortgage will not change during the term of the mortgage. Rates for lifetime mortgages have been edging down in recent years and are not much higher than ordinary residential mortgage rates.

Although no money is repayable during your lifetime, the interest ‘rolls up’ so that interest becomes payable on interest – an effect which is referred to as ‘compound interest’.

WARNING!At 7 per cent compound interest, your debt will double in just over 10 years so a £30,000 mortgage would balloon to £116,000 over 20 years.

This means that, if you live a long time, the effect of compound interest could exhaust the equity in your property, or even cause your total debt to exceed your property’s value.

This is why it may be advisable to use a Safe Home Income Plans (SHIP) member, as the latter guarantee to never do re-possess your home. Depending upon the plan terms a non SHIP provider could insist on re-possessing your property if there is no more equity in it. Visit Safe Home Income Plans for a list of SHIP members.

However, SHIP is only a trade association, not a regulator. If you have a complaint about a lifetime mortgage, you should ultimately contact the Financial Services Authority.

TIP

Lifetime mortgages charged on a daily basis work out cheaper for the borrower. This is because with a lifetime mortgage you want to delay interest being applied to your mortgage for as long as possible because once added to your existing debt, it starts to attract compound interest.

By contrast, with a standard mortgage, you want to pay off interest as quickly as possible to reduce your debt which will happen if the interest is applied daily.

Not all the quoted rates for lifetime mortgages are on an annual basis, so ask your adviser to check out whether the interest will be applied daily or annually.

Drawdown facilities

In recent years lifetime mortgages have increasingly be arranged on a drawdown basis. This means you can withdraw a small lump sum, of, say £10,000, from your overall lending facility of, say, £50,000, and draw down further similar amounts in later years, if needed.

It’s a bit like having an overdraft facility agreed with your bank manager that you can draw on, as and when you need it.

This makes your borrowing less expensive as you only pay interest on the amount you have actually withdrawn, or ‘drawn down’ as it is referred to.

In other words, the less interest accruing, the more equity will still be in your property when you die. But you should not bank on ANY equity remaining in your property as compound interest can erode the equity in your property at a frighteningly quick rate.

Home reversion plans

A home reversion plan involves you selling a proportion of your property to a home reversion company in return for a lump sum or an income for life. Home reversions have been less popular than lifetime mortgages – possibly because the concept of a home reversion is less familiar to elderly people than taking out a mortgage.

The amount you will receive from a reversion company will be dictated by your age, sex and state of health. The shorter your life expectancy, the more you will receive.

For instance, a single woman of 75 will receive slightly less than a man of the same age in an identical property, because women tend to live longer – which means the reversion company will have wait longer to be able to sell the property.

A 65 year old male, wanting to sell 50 per cent of a property worth £300,000, might be offered about 43% per cent of £150,000, or £64,500, while a woman of the same age would receive roughly £57,000.

One of the main advantages of home reversions is that you know exactly what percentage of the value of your property will pass to your beneficiaries, so home reversions may be suitable for those for whom leaving an inheritance is important. Some lifetime mortgages will also offer a ‘protected equity’ option.

For instance, in the above example, if you died 10 years later and the property had risen in value from £300,000 to £500,000, the home reversion company would reclaim £250,000 (still 50 per cent) when the property is sold, while your estate (and ultimately your beneficiaries) would also receive £250,000 (still 50 per cent).

Home reversions are offered by a fairly limited number of providers and these include Bridgewater Equity Release, Hodge Equity Release, Norwich Union and Retirement Plus.

Home reversions have been regulated by the Financial Services Authority since April 2007.

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What are the costs?

Lifetime mortgages fees

Taking out a lifetime mortgage will involve a valuation fee, the cost of which will depend on the value of your property.

Arrangement fees range vary from plan to plan but are typically in the region of £400 to £700 and legal fees vary regionally and according to the value of your property, but are likely to be in the region of £300 to £500 +VAT.

Some plans will pay or refund these fees upon completion.

Some advisers will also charge a fee for arranging equity release plans.

Home reversion fees

These plans will also require a valuation, the cost of which will vary according to the value of your property.

There will also be a fixed application fee of up to £800, although at the time of writing the majority of providers are not charging a fee.

Legal fees will depend on the value of your property and the complexity of the conveyancing, with some providers requiring you to pay two sets of solicitors’ fees- theirs and yours.

Many providers currently pay or refund these fees.

WARNING! You should ALWAYS check with your local Benefits Office what effect the receipt of a lump sum or extra income generated by equity release might have on your current or future entitlement to state benefits such as pension credit, savings credit and council tax rebate.

You should also check what effect any equity release proceeds may have upon your tax liability.

Many qualified equity release advisers will be able to explain the effects on benefits and tax.

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Pros and cons of the different kinds of equity release

Lifetime mortgages

The pros:

  • Using a drawdown facility is a cost effective way of accessing your equity release reserve because you only pay interest on the money you have actually withdrawn.
  • Lifetime mortgages are regulated by the Financial Services Authority (FSA) giving you some protection if you have to make a complaint about the advice you have been given.
  • A lifetime mortgage can help you take various IHT-reducing measures, such as gifting the money away or taking out a large life assurance policy, with the proceeds gifted to your beneficiaries. But it can be finely judged move if you live for a very long time because the interest on the lifetime mortgage may exceed the reduction you achieve in IHT. Generally IHT should not be the only reason that you take out an equity release plan.

The cons:

  • Most lifetime mortgages charge early repayment fees if you want to repay your mortgage.
  • If interest rates fall during your lifetime, your mortgage will be locked into an uncompetitive rate of interest.
  • The effect of compound interest rolling up means that the equity in your property could be completely exhausted before you die. This could result in your home being re-possessed if you don’t have a ‘no negative guarantee’ from your lender.
  • A cash lump sum or extra income may affect your entitlement to certain state benefits such as pension credit, savings credit and council tax rebate. Be sure to check with your local Benefits Office before signing on the dotted line.
  • Extra income may affect your age allowance or tax liability

Home reversion plans

The pros:

  • You will know exactly what percentage of your property will be left to your heirs when you die.
  • A home reversion may enable you to take various IHT-reducing measures, such as gifting the money away, or taking out a large life assurance policy with the proceeds gifted to your beneficiaries. The cost of doing a home reversion may exceed the IHT reduction you achieve.

The cons:

  • You are responsible for the repair and maintenance of your property and for all property-related bills such as council tax.
  • You no longer ‘own’ your own home.
  • If you die or go into long term care within a few years after you have taken out a home reversion the plan may prove to have been a very expensive transaction.
  • A home reversion plan may affect your entitlement to certain state benefits such as pension credit and council tax rebate.

This list is not exhaustive and you should get your adviser to explain all these and other potential advantages and disadvantages in detail

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Seeking your advice

Any equity release provider will insist that you seek independent financial advice at your own cost before signing up. When looking for an adviser, choose one that is a specialist in equity release and holds the Certificate in Regulated Equity Release from ifs School of Finance or the Certificate in Equity Release from the Chartered Insurance Institute.

Equity release by its nature is a long term product and it is very important to get appropriate advice.

Complaints

If you have any complaint against a member of SHIP, you must first contact the individual company directly and try and resolve the issue with that company.

Most SHIP members are regulated by the Financial Services Authority (FSA) and as such are required to follow strict procedures on how complaints are dealt with, including the timescales for dealing with these issues.

This includes a five day turn around for acknowledgement of the complaint, prompt investigation and regular updates on progress.

If you are unhappy with the outcome of this investigation, you can then refer your complaint to SHIP or to the Financial Ombudsman Service (for FSA regulated firms).

Financial Ombudsman ServiceSouth Quay Plaza183 Marsh WallLondon E14 9SR0845 080 1800 (Rates may vary)

Or visit the Financial Ombudsman's Service website

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Last updated: Sept 08

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