Demand for equity release mortgages has reached record levels in recent years. More lenders have entered the market, increasing competition and lowering interest rates. For those over 55 years old who own their property outright, equity release mortgages provide a way to generate a lump sum or regular instalments of cash.
What is an equity release mortgage?
Equity is the value of how much of your property you actually own. Equity release mortgages allow those with 100% equity in their property (in other words, you have paid off the mortgage and own it completely) to access some of that equity, in either one lump sum or regular increments.
In the past equity release mortgages and related products were plagued by hidden charges and the industry suffered from a poor image. This has improved lately, but equity release mortgages can still be a costly way to release cash from your home and are not suitable for everyone. It is therefore very important to weigh up the pros and cons before you go ahead.
It’s important to note that equity release mortgages and remortgaging to release equity in your home might sound like the same thing, but they are different.
Remortgaging when you’re over 55 can be difficult because of the length of the mortgage term, which is usually 25 years. You become a risky investment for the mortgage lender because you will not have paid off the mortgage debt until you are 80 years old. This is why over-55s turn to equity release mortgages.
Read our full guide on whether or not you should remortgage
How do equity release mortgages work?
There are two main types of equity release mortgages and they each work slightly differently from one another:
- Lifetime mortgages
- Home reversion mortgages
What is a lifetime mortgage?
Lifetime mortgages are probably the most popular kind of equity release mortgage. You are allowed to stay in your current property and can keep a set percentage aside, perhaps as an inheritance for your family. To qualify, you must be 55 or over and own your property outright.
The property must be your main residence and you can usually only borrow up to 60% of its value – which you may or may not be able to pay back in instalments depending on your lender, your age and your health. Being older with medical conditions could mean a lender gives you more than if you are 55 and in good health.
The loan accrues interest, which if you decide not to repay over its course “rolls up” – this type of lifetime mortgage is called an interest roll-up mortgage. This accrued interest is referred to as compounding interest and essentially means you end up paying interest on the interest. As the interest builds up over the years, you may find that you owe a substantial sum to the mortgage company.
If you opt for an interest-paying lifetime mortgage, you can pay off the interest (and sometimes even the capital) in instalments, so you avoid the compounding interest pitfall. This is not the same as a retirement interest-only mortgage.
When you die or move into long-term care, your home is sold to pay off the debt and the interest.
Some equity release mortgages have a “no negative equity guarantee”. This means that should property values fall and there is insufficient equity to repay the loan in full, neither you, your heirs, nor your estate will need to pay more. Without that guarantee, you or your beneficiaries would have to pay the difference between the amount the property was sold for and the remainder of what you owe.
You will most likely need to take legal advice, particularly over how the repayment of interest might affect any inheritance that your children or grandchildren had hoped to receive.
What is a home reversion mortgage?
With a home reversion mortgage you can sell a portion or all of your home, at below market rate (usually between 20% and 60% of the market value), to a home reversion provider. You will receive payment in a single lump sum or regular monthly instalments. You may need to be at least 60 or 65 years old to be eligible for a home reversion mortgage.
You have the right to live in your home, though most home reversion plans have a clause requiring you to maintain and insure your property. When you die or move into long-term care that point, it’s sold, and the home reversion company takes their share of the proceeds – including any increase in market value over the time the plan has been in place.
You can always move house, but the home reversion provider will need to deem the new property acceptable. This is because the new property becomes the security on the loan it’s given you.
Remember, the sale of part (or all) of your home will mean there is less for your heirs to inherit.
Long-term, home reversion will most likely work out much more expensive than selling your home and downsizing, primarily because you sold at below market value. There are also arrangement and early redemption fees if you change your mind once you’ve taken out a home reversion mortgage, not to mention legal fees if you hire a solicitor.
Equity release interest rates and charges
When considering equity release, you need to think about the effect of interest charges on the amount you owe. Unlike a traditional mortgage, the interest period is open-ended and only finishes when you die or go into long-term care.
The average interest rate on equity release mortgages is much higher (currently around 5.1%) than for an ordinary repayment mortgage (for example, the average two-year fixed-rate mortgage in the UK is 2.5%) on a house or flat, which means debt builds up more quickly, especially if you are rolling up rather than paying it off.
But equity release mortgage rates have gone down over recent years. “There is more competition and more demand for the product, and rates have fallen as a result,” says financial planner, Warren Shute. “Baby boomers on the whole have paid off their homes and are coming up to retirement, and they do not want to move or downsize, but they do want to access the money they have got in their home. The cost of moving, stamp duty, and having to find a suitable property mean that many of them want to stay put, but they want to spend a bit more money in their years of retirement and they are looking to generate money via releasing equity from their home.”
Drawdown lifetime mortgages continue to be more popular with older customers than lump sum plans, as well as making up three quarters (76%) of all new plans agreed. The average age of a drawdown customer is around 72.
What are the alternatives to equity release?
Rather than using your home as a source of income, you could draw down on your pension instead. New pension freedoms enable you to access your pension pot from age 55, and to use your fund more flexibly, without the need to purchase a fixed regular income in the form of an annuity.
Shute said one in four homeowners taking out new drawdown plans are aged 75-84, suggesting that people are starting drawdown plans later in life, potentially to provide a new source of income as others run out or boost existing sources as circumstances change.
Customers aged 55-64 also accounted for the smallest share (32%) of new lump sum lifetime mortgages since tracking began. Over-75s made up 15.5% of new lump sum plans taken out – the highest share seen to date.
Now read our guide how much money you need for retirement
Image credit: Stephen Zeigler/Getty Images