Dangers of Equity Release – What You Need to Know
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What are the dangers of equity release? There are lots of pros and cons to consider before you release equity using a lifetime mortgage or other scheme.
In this new MoneyNerd guide, we recap the basics of equity release in the UK before diving into some of the dangers of equity release. Many common concerns can be put to bed by choosing specific lenders. Learn more here!
What is equity release?
Home equity is the value of your home that you own outright with no attached debt, which increases by making mortgage repayment or rising house prices. Equity release schemes allow older homeowners to access some of their home equity to pay for retirement, home renovations or something else.
Once the equity has been released, the senior homeowner does not need to make any monthly repayments. Instead of repaying the loan each month, it is only repaid when the property is sold, which occurs when the homeowner moves into long-term care or after they die.
This is different from a home equity loan most often used by younger people.
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Equity release eligibility
The criteria to apply for equity release schemes are determined by each individual lender. In general, the homeowner or homeowners will need to meet a minimum age requirement, which is usually 55, 60 or 65 years old.
The youngest of a couple must meet this age requirement. If you are ever told to remove a non-qualifying homeowner from the property to be eligible, this is usually very dangerous advice.
You’ll also need to have no existing mortgage on the property and the property must meet a minimum value, typically around £75,000.
What is the catch with equity release?
The ‘catch’ of equity release is that it becomes extremely expensive over time. Although you will receive money and not have to make ongoing repayments, the total debt you will have to pay back can easily be more than double the amount you release. This can put a significant dent in the value of your estate that you wish to pass on to loved ones.
However, this shouldn’t really be considered a catch as the details of any form of equity release should be rigorously explained to you beforehand. It’s a negative aspect of equity release, but it shouldn’t be there to catch you out.
Lifetime mortgage vs home reversion scheme
There are two ways to release equity in the UK, either by using a lifetime mortgage or a home reversion plan.
Lifetime mortgages are the most common method. They allow the senior homeowner to access some of their home equity up to a maximum of around 60% and then charge a fixed interest rate on this amount. Neither the loan nor the interest has to be repaid each month. The interest debt accumulates and gets added to the total loan amount. Whatever is owed when the home is sold is how much the lender takes from the sale proceeds.
For example, you might own a £180,000 home and use equity release to get a £65,000 loan with a fixed 6.4% interest rate. After 12 years, you need to move into an aged care facility. By this time, the debt will have grown to around £137,000. If you sell your property for £200,000, the lender will recover the £137,000 debt owed and you’ll be left with £53,000.
Home reversion scheme
A home reversion scheme is a less common form of equity release method but it does provide more certainty. The lender will usually not charge any interest on the amount of equity taken out. Instead, the lender asks that you give up a greater percentage of your property’s future sale proceeds.
It’s simple to understand with an example. Let’s imagine you own a £170,000 home and want to access 20% of your home equity. You receive £34,000, and in exchange, agree to give up 50% of your home’s value when it is sold – when you die or move into care. The home doesn’t need to be sold for 15 years and over that time the property has increased in value by £30,000. It sells for £200,000 and the lender takes 50% (£100,000) of the sale proceeds.
Enhanced lifetime mortgages
There’s also a variation of a lifetime mortgage called an enhanced lifetime mortgage. These are primarily for people with a shorter life expectancy. The lender allows people who can prove they have a shorter life expectancy to access more home equity than normal, which may be helpful when paying for private healthcare services.
Lump sum vs drawdown equity release
Both a lifetime mortgage or home reversion plan can provide the money as a cash lump sum or as a drawdown facility. With the former, you receive all of the equity taken out as one payment, and with the latter, the money is readily available for the homeowner to access when they need it.
Using a drawdown equity release plan can mitigate the cost of interest payments and it may protect your eligibility to some means-tested benefits. We’ll come back to this later.
Is it safe to do equity release?
Using equity release schemes is safe as long as you engage an independent financial adviser first and only use an equity release provider that is legally operating, meaning they are regulated by the Financial Conduct Authority.
Many of the pitfalls of equity release can be avoided by choosing a lender that is a member of the Equity Release Council (ERC). This is a body that asks all members to adhere to rules and guidelines that have been made to offer greater protection to senior homeowners. You’ll hear more about the Equity Release Council in this guide.
Can you lose your house with equity release?
When you use a lender that is a member of the Equity Release Council, they must guarantee that you’ll never be forced to leave your home or sell it unless you enter into long-term care.
However, there are a few other rare scenarios that may result in your home being taken and sold. These are:
- You lied or committed fraud on your equity release application
- You are not really living at the property anymore but have been avoiding telling the equity release company
- You have purposefully stopped maintaining the property
The benefits of equity release
You should always do your research on the pros and cons of equity release. Let’s start with those pros:
- You can receive a cash lump sum or drawdown
- The money is tax-free
- No monthly repayments are required
- No rent is required – it’s still your home
- It can be spent on anything the homeowner prefers
- When protected by the ERC’s negative equity guarantee, you will never have to pay back more than what your home sells for. So, if the debt grows bigger than your home’s value (i.e. having negative equity), you won’t have to pay the extra
- You can make voluntary interest payments to keep the total debt down if needed
The pitfalls of equity release
The first pitfall of equity release is using it when it is not the best option for you. For example, using any significant savings before deciding to release equity is usually more advantageous. Your financial adviser should ensure you make the right choice, and any mis-sold schemes can be complained about to the FOS.
When you do have consultations with your adviser, it is important that you reveal all your plans and don’t conceal any information. Doing so could have disastrous and costly repercussions. For example, not telling your adviser you want to downsize in 10 years could result in an eye-watering fee that may have been avoided.
If you do decide to use equity release, it’s important that you only release what is needed. Because the costs of releasing equity in this way are so high, you don’t want to overborrow. Using a drawdown facility can be helpful if you don’t know exactly how much you need to release.
Another potential pitfall of equity release is not being aware of how your new wealth will affect entitlement to some state benefits. We’ve dedicated an entire section to this below…
Can you lose access to benefits?
When you take out an equity release plan, the amount of savings you have will instantly increase. This can stop your eligibility to receive some means-tested benefits.
You’ll still be eligible to receive a state pension, but those who received pension credits to top up their pension may no longer be eligible to receive a partial or complete top-up.
For every £500 you have above £10,000 in savings, your pension credit payments decrease by £1. If you lose all entitlement to pension credit payments, you can simultaneously lose entitlement to a council tax reduction and some other benefits.
By using a drawdown equity release plan instead of receiving a lump sum, you might be able to mitigate the amount you have saved at one time, which could protect your right to receive some means-tested state benefits.
Can you move home with a lifetime mortgage?
The Equity Release Council states that all its members should allow homeowners to move to suitable alternative properties and take their lifetime mortgage with them. For a property to be seen as suitable, it must be of equal or greater value than the original property. But that’s not all – it must be just as easy to sell on the property market.
For example, moving to a home of equal value in the same town or city should be fine, but moving to an exceptionally remote location could cause issues because the new home might be harder to sell in the future.
If you want to downsize to a different property with a lower valuation, this is usually possible but it may be costly. You may need to pay off some of the lifetime mortgage to be allowed to downsize, and this could trigger an early repayment charge. It is essential that you explain any downsizing plan when you receive financial advice. Your adviser may be able to secure an equity release agreement that excludes early repayment costs when paying off part of the mortgage within a downsizing process.
Is equity release worth considering?
Equity release is worth considering for some people. If you have savings already and don’t have specific plans for the money you’ll receive, it could be a sign that releasing equity is an unworthwhile long-term expense.
You should always seek independent financial advice from equity release experts to inform your decision.
When is equity release a good idea?
Releasing equity is a good idea if you need cash in later life to live a more comfortable retirement and do not have enough savings already. The decision is made even easier if you do not have any children or grandchildren to benefit from your estate.
The decision is not entirely a financial one, which means releasing equity is a very personal decision.
Alternatives to equity release
An alternative way to access cash as a senior without using equity release is to sell your home and downsize to a smaller less valuable property. This could help you access some cash for retirement.
But some negatives of this option is that moving can be stressful and you may have a sentimental attachment to your current family home.
More on the dangers of equity release
To learn more pros and cons of equity release schemes as well as other relevant discussions about releasing equity as a senior, stick with our blog at MoneyNerd.
We just released over 100 guides on these subjects to help you easily understand what can be a daunting way to access your equity.