Equity Release Loan – Complete Guide for 2022
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An equity release loan, also known as a lifetime mortgage or home reversion plan, is one way of making retirement more comfortable for suitable seniors. Learn everything you need to know about equity release loans in the UK, including how they work and FAQs, right here!
What does it mean to release equity?
Releasing equity is when someone takes out a loan secured by some of the monetary value they have within an asset. Releasing equity is usually done on properties where the homeowner has paid off a large chunk or all of their residential mortgage and then uses some of the property value to access a loan. This money may be used for an array of reasons, not limited to home improvements, debt consolidation or even to buy another property.
You can work out how much equity you have in a property by taking away your existing mortgage balance and any other loans secured by your home away from the current value of your home (not the value of your property when you bought it).
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What is an equity release loan?
An equity release loan refers to two types of equity release called lifetime mortgages or home reversion plans. These loans are exclusively available to senior homeowners who want to release equity from their property but are not typically able to get conventional equity loans.
Because they are only available in later life, they work differently from conventional loans by not asking for any monthly repayments. The equity release loan is only repaid after the homeowner dies from the sale of the property.
There may be a time when the equity release loan needs to be paid back sooner, i.e., if the senior homeowner moves out of their property and into long-term care.
Who qualifies for equity release?
Equity release loans are only available in later life and the youngest homeowner will need to be at least 55 years old to access a lifetime mortgage or home reversion plan. Some lifetime mortgage providers may require you to be slightly older.
On top of the age requirement, you must be releasing equity from a property that is your main residence with no outstanding mortgage. Some properties that are worth below a certain value are not accepted for lifetime mortgages. You should be able to find an equity release loan as long as your home is worth at least £75,000.
The above will make it possible for you to apply, but the equity release lender will still carry out checks on the property before offering a loan. The property must conform to building standards and tick a list of other requirements, such as not being located in a high flood risk area.
Equity release loans vs home equity loans
It’s important to differentiate between lifetime mortgages and home reversion plans – which fall under the category of an equity release plan – and home equity loans.
As mentioned, the former are exclusively available to senior homeowners, while home equity loans are also loans that are secured by home equity but they are for younger homeowners still with mortgages to pay. Home equity loans must be repaid through monthly repayments with interest or a fixed period.
What is the catch with equity release?
Equity release loans can sound like an attractive deal. You unlock some of your equity as a tax-free lump sum and never have to make repayments. The debt is only repaid after you die or move into care through the sale proceeds of your property.
But the catch with equity release is that these can be very expensive loans. Both lifetime mortgages and home reversion plans can more than double the amount you owe (and more!), which significantly eats away at any inheritance you planned to pass on. This is why equity release is a much easier decision for those without children.
How exactly does equity release work?
Either form of equity release works by not asking for monthly repayments, and instead only recovering the debt after the property is sold after death or moving into care. But a lifetime mortgage and home reversion plan work in notably different ways:
A lifetime mortgage is the most common method of equity release. Homeowners can assess a lump sum loan or a drawdown which gives access to regular smaller payments. In the best-case scenario, you can get up to 60% of your equity as a loan.
This money is charged with rolling interest that is also not repaid each month but keeps adding to the total debt. Whatever the total is when it is time to repay the loan is how much of the property sale proceeds will be paid to the lender. Some lifetime mortgage providers allow voluntary interest payments so you can keep the debt down over time.
Home reversion plan
Not as common as a lifetime mortgage, a home reversion plan offers up to 80% equity loans at best and does not add any interest to the loan amount. The lender will guarantee a profit by getting the homeowner to agree to pay a larger percentage of the property’s future sale proceeds in comparison with the percentage of equity taken out.
For example, you might release 35% of your home equity and then have to pay 70% of the property’s sale proceeds in the future. This means you would eventually be paying double – or more if the value of your home increases over time – for your loan.
How much can I borrow on equity release?
On average, a lifetime mortgage will enable the homeowner to access up to 60% of their equity as a lump sum or drawdown, while a home reversion scheme can allow up to 80%. So, someone with a £200,000 home might be able to get an equity release loan worth up to £120,000 or £160,000 respectively.
The amount of equity you can access will depend on the lender, your age and details about your home. In general, the older you are the better chance you have of releasing more equity.
There is a variation of a lifetime mortgage called an enhanced lifetime mortgage which can help applicable seniors to release more equity than standard. Enhanced lifetime mortgages are for people with shorter life expectancies who may use the additional equity to help fund private medical and care services. To apply for an enhanced lifetime mortgage you will need to fill out a health and lifestyle questionnaire and possibly supply the lender with your medical records.
What is the Equity Release Council?
The Equity Release Council (ERC) is a voluntary membership group that invites equity release lenders and financial adviser companies to join and abide by the group’s rules and standards when offering equity release loans. These rules have been created to protect senior homeowners and all members must be authorised and regulated by the Financial Conduct Authority. Thus, any member is usually a more appealing lender compared to those who are not.
What is the negative equity guarantee?
The negative equity guarantee is one of the many ERC rules and guidelines designed to protect senior homeowners releasing equity. It states that the homeowner must never be chased for debts that exceed their property’s sale value. Any shortfall between the sale proceeds and the debt must be written off.
For example, if you have a lifetime mortgage for over 20 years and paid no voluntary interest, the debt you owe might have grown above your property’s value. So when the property is sold, all for the sale proceeds will be paid to the lender, but the rest of the debt does not have to be paid by you, your estate or estate beneficiaries.
What are the drawbacks of an equity release loan?
The main drawback of equity release products is how expensive they can become. Some other drawbacks include the cost of setting them up, especially when it is mandatory to engage with a financial adviser. Additionally, the early repayment charges on these loans are excessive, making it almost impossible to get out of your agreement once signed.
Does an equity release loan affect state pensions?
Equity release does not affect eligibility to receive a state pension because state pension payments are not a means-tested benefit. Pension credits are means-tested and those with more than £10,000 will see their payments reduced or removed. If you release equity, your new wealth could mean losing access to all pension credits, which could then prevent you from qualifying for a council tax reduction.
Are equity release loans taxed?
The money you receive from personal loans in the UK is not subject to tax and you will therefore not have to pay tax on the money you receive from an equity release product. There might be inheritance tax implications of releasing equity and giving the money away, which is best discussed when you receive personalised financial advice.
Can you move house after getting an equity release loan?
If you use a lender that is a member of the Equity Release Council, one of their rules states that you should be allowed to move property and take your equity release product with you. You must be moving to a suitable property that the lender will have equal difficulty selling, such as moving from one suburb to another. Moving to unique properties like boathouses may cause problems.
If you want to move to a smaller property that is less valuable, you will be asked to pay off some of your loan and this may trigger early repayment costs. You can avoid these additional costs by telling your financial adviser about plans to downsize in the future, so they get a downsizing clause added to your credit agreement.
Can you be denied an equity release loan?
Even in later life, you can be denied either type of equity release if you have active CCJs or a Charging Order on your property. But the most common reason for equity release being denied is because of the property itself. It may have been built wrong, there might be asbestos present or it could be in a flood risk area. These are some reasons why lenders will deny lifetime mortgages and other plans.
Discover more about releasing equity in the UK!
Now you know the basics of equity release loans in the UK, why not brush up on some of the specifics and finer details? MoneyNerd has plenty more equity release guides covering these unique loans from all angles. Check them out soon!