Disadvantages of Equity Release – What You Should Know
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What are the disadvantages of equity release? Anyone considering a lifetime mortgage or home reversion plan should be aware of the pros and cons of these schemes. This guide is dedicated to looking at the advantages and disadvantages of equity release, with special attention paid to the latter.
Read on to uncover more and get professional equity release advice before making a decision.
What is equity release?
Equity release is an option for senior homeowners. It allows them to access some of their home equity as either a lump sum or drawdown facility. This money and any applicable interest do not need to be paid back through monthly repayments like most other forms of credit. Rather, it is eventually repaid when the property is sold.
The only occasion when you’ll be forced to sell your home is if you have to move into long-term care. If you never need to go into care and have no plans of selling to move home, then the debt will be repaid through the sale of your home after death, which will have an effect on the inheritance you pass on.
There isn’t just one form of equity release. It can be completed through a lifetime mortgage, enhanced lifetime mortgage or a home reversion plan. Only consider any of these equity release schemes through a provider that is authorised and regulated by the Financial Conduct Authority (FCA).
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Is equity release worth considering?
So, is equity release a good idea and worth considering?
The answer depends on individual circumstances. For some people, the benefits of equity release far outweigh the negatives and is a great way to access tax-free cash for retirement. However, for others it may be less appealing, especially if you don’t really need an additional retirement income or if you want to pass on as much inheritance as possible to loved ones.
You should always engage a financial adviser if you are considering releasing equity.
How does a lifetime mortgage work?
A lifetime mortgage is the most used type of equity release plan in the UK. It allows you to take out some of the value of your home as a cash lump sum or drawdown. This money is charged with a fixed interest rate. You don’t need to make monthly repayments on the principal loan or the interest charged.
Instead, the interest accumulates over time and gets added to the total debt owed. So, the longer you have the lifetime mortgage the more the debt grows, and this total is only repaid when the home is eventually sold. You can usually make voluntary payments to clear some or all of the interest each month.
When your provider is a member of the Equity Release Council (ERC), they must commit to a negative equity guarantee that states you are never liable to pay more than what is raised through the sale of the home. This will ensure the company can never collect any shortfall through other money in your estate.
There’s also an enhanced version of a lifetime mortgage. This is when the applicant must submit a health questionnaire and possibly provide the lender with medical records. If you are deemed to have a shorter life expectancy, the lender will let you access more equity than normal. This could be used to pay for private at-home care.
What is a home reversion plan?
A home reversion plan is when the equity release provider offers an amount of money in exchange for a percentage of the property’s eventual sale proceeds. No interest is charged but the amount you are offered is well below the percentage’s real value. For example, you may be given 20% of the value of your property, but the company will take 60% of the sale proceeds in the future.
Why do people choose equity release?
Equity release is only available to people in later life and is therefore predominantly used to fund retirement. This may just be a nest egg for each year, or it could be to pay for home improvements, holidays, cruises or to fund private medical care. You might even release equity to pay off debt.
Some seniors will gift the money to friends and family to help them buy their own family home or start businesses.
Are there any cons of equity release?
Yes – both lifetime mortgages and reversion schemes have disadvantages, such as the overall cost, eye-watering early repayment charges and more. We discuss the main cons of equity release below.
What are the disadvantages of equity release?
The main cons of equity release are:
- Overall cost
The overall cost of any equity release plan is expensive over the long term. Releasing just £65,000 through a lifetime mortgage at a standard 6.4% interest rate will equate to almost £137,000 total debt after just 12 years. This means the value of your home left to beneficiaries can be severely reduced.
It’s also mandatory to get professional advice and legal services, which add to the total cost of the process.
- Early repayment charges
These schemes are designed to last for the rest of your life and it is therefore very expensive to try and get out early. The early repayment fees on a lifetime mortgage are exceptionally expensive, usually more so than other mortgages.
- Losing means-tested state benefits
Accessing part of your home equity as a lump sum will instantly increase the amount of savings you hold. This may affect your entitlement to some means-tested state benefits. You cannot lose your state pension, but you may lose your pension credits. If you do, you could then lose your entitlement to a council tax reduction. Anyone with more than £16,000 savings won’t be eligible to receive Universal Credit either.
But, what are the advantages of equity release?
The advantages of equity release from a member of the Equity Release Council are:
- Tax-free lump sum or drawdown with no monthly repayments
- Voluntarily keep the debt lower with repayments if desired
- Spend the money on anything you wish
- You’ll never be forced to sell or move out; you’ll only have to sell after you die or move into care
- You have the right to move home and take your lifetime mortgage with you
- You never owe more than what your home sells for, protecting the rest of the value of your estate
- You can ‘ring fence’ some of your property value for beneficiaries
- A downsizing clause will allow you to downsize and pay off some of your lifetime mortgage without having to pay early repayment fees
Do you have to pay tax on equity release?
The sum of money you release from your home is a loan, although it may not feel like it because no ongoing repayments are required. Because it is a loan, you do not need to pay income tax or Capital Gains Tax (CGT) on the money you receive.
How to avoid the pitfalls of equity release
You can do five things to avoid the pitfalls of equity release. These are:
- Get independent advice from a financial services company that has experience working for clients in equity release.
- Tell your adviser about any future plans, such as plans to move home or downsize in the future.
- Only choose a lender that is regulated by the FCA.
- Only choose a lender that is a member of the ERC.
- Don’t rush into a decision and do your own research.
Is equity release a good or bad idea?
Equity release is neither a good nor bad idea for everyone. The decision to use an equity release scheme should be based on personal circumstances. For some people with nobody to leave their estate to, it can be an easy decision, whereas for others with children who could really benefit from inheriting a family home, it’s not such an easy decision.
More advantages and disadvantages of equity release!
Read more MoneyNerd equity release guides as we discuss some of the pros and cons of these schemes in detail, and touch on relevant questions and discussions not mentioned above. All our equity release content is free and we now have over 100 dedicated guides on the subject. If you have an equity release question, we’ve probably answered it already!