Equity Release Rules – What You Need To Know 2022
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What are the equity release rules when it comes to lifetime mortgages and any other equity release plans? We discuss and explain lots of equity release rules from eligibility to the Equity Release Council and even on spending your cash lump sum.
Always engage with an equity release adviser as part of the process, but start your own understanding with MoneyNerd here!
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What is equity release?
Equity release refers to two main financial loan products available to senior homeowners who want to access some of their home equity as either a cash lump sum or as a drawdown. The money is not repaid through monthly instalments, as is the case with nearly all other types of lending.
The homeowner only pays back their home when they sell the property, which the majority of the time will happen either:
- If they move into long term care – they must sell their home to pay off the debt as they are no longer residing there.
- They pass away – in this case, the loan is repaid from the sale proceeds of the property as part of the estate.
What is the catch with equity release?
Equity release might sound too good to be true. You really do receive cash and do not have to make a repayment while you’re alive unless you move into long-term care. But the ‘catch’ is that the eventual total cost of equity release can be eye-watering.
The amount you have to eventually pay back can easily be more than double the amount you borrowed. This puts many people off equity release, especially if they wish to give as much inheritance as possible to loved ones.
How does equity release work in the UK?
There are two main types of equity release products in the UK, namely a home reversion scheme or a lifetime mortgage. There are some slight variations of lifetime mortgages, such as an enhanced lifetime mortgage for people to access more money if they have a shorter life expectancy.
We discuss and explain a standard lifetime mortgage and home reversion plan below.
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Lifetime mortgage Vs home reversion scheme
A lifetime mortgage is the most used type of equity release plan by UK residents. With a standard lifetime mortgage, the homeowner can access up to 60% of their home equity as a lump sum or drawdown. The amount they release is charged with a fixed interest rate. The interest rolls up rather than needing to be repaid, meaning the total debt grows over time.
Some lenders allow the homeowner(s) to make voluntary repayments to reduce the accumulating interest debt. Doing so would prevent the debt from more than doubling over the course of a decade, which is not out of the ordinary.
For example, taking out £65,000 with a lifetime mortgage that has a fixed interest rate of 6.4% can equate to almost owing £137,000 after just 12 years if no voluntary interest payments are made.
On the other hand, a home reversion scheme doesn’t charge interest but can be just or even more expensive. The lender agrees to loan you some money in exchange for a repayment from the eventual sale proceeds. But the percentage you’ll have to pay back will be much greater than the value of the loan you receive.
For instance, you might take 20% equity of your £120,000 home (£24,000) but have to pay back 60% of its sale value, which could be around £72,000 or more depending on how the property value changes over time.
What are the equity release rules? (eligibility)
The exact eligibility rules for any equity release plans will be determined by the individual lender. As standard, you must be releasing equity from your main residence that meets a minimum valuation of around £75,000 and has no debts attached, such as a first charge mortgage. Some may allow you to release equity with a small mortgage that you plan to pay off as part of the equity release process.
As an equity release plan is only available to seniors, there is also a minimum age requirement. Depending on the type of equity release plan and the lender chosen, you must be at least 55, 60 or 65 years old to use their equity release product. The older you are typically means you can get a lower interest rate.
Do both parties have to be over 55 for equity release?
When the minimum age requirement is set at 55 years old then this applies to both homeowners. If your equity release adviser suggests taking someone who is too young to qualify for equity release off the property ownership – be extremely cautious. This can be really bad advice and open any younger surviving partner up to losing their home in later life.
The Equity Release Council (ERC)
The Equity Release Council is a group that offers voluntary membership to equity release advice companies and lifetime mortgage providers. All members must be legitimate, meaning they must already be authorised and regulated by the Financial Conduct Authority.
Once joined, the lifetime mortgage provider must commit to upholding high standards and abiding by the group’s equity release rules and guidelines.
Equity release rules with the ERC
The equity release rules and guidelines created by the council have all been made to keep homeowners protected and provide them with greater reassurances when taking out a lifetime mortgage or other equity release product.
It’s highly recommended to only consider lifetime mortgages or home reversion plans from lenders that are ERC members. By doing so, you’ll benefit from an array of assurances, such as:
- The negative equity guarantee – as shown in our example earlier, lifetime mortgages can be expensive and easily double your debt in 10-15 years with a standard interest rate. You may be worried that if you live for a long time that the amount you owe will be greater than the value of your home and what it will sell for. The negative equity guarantee means that you never have to pay any outstanding debt beyond the sale proceeds, which could leave more money in your estate for your loved ones.
- You’re free to move – With an ERC member, you are allowed to move to a suitable alternative property and take your lifetime mortgage to the new property. A suitable alternative is another property that will be just as easy to sell in the open market and of similar or higher value.
- You’ll never be forced out of your home – ERC members must guarantee anyone that takes out a lifetime mortgage that they will not force them out of the property or repossess it in any normal circumstances. The only time this may not apply is if you have committed fraud on your application or are purposefully damaging the property.
What are the rules on spending equity release?
There are no restrictions on how you can spend your lump sum or drawdown money. Most people spend the money on making their retirement better, which may just be easing the financial burden of everyday expenses, renovating a home so it is more elderly-friendly, or going on more holidays each year.
Some homeowners decide to invest the money in a new property, such as a rental investment or holiday home. If you decide to buy a holiday home, there can be some complications and things to note.
Lifetime mortgage debts can be recovered if the homeowner is no longer living at the property, hence why it becomes due if you move into a residential care home. If you buy a second home and live in it for too long each year, you could be judged to have changed your residential address and therefore owe the money back immediately. The specifics of these rules will be determined by your lifetime mortgage provider.
How much equity can I release?
The amount of home equity you can release will depend on the lender’s maximum loan to value ratio, your age and factors related to your property. There could be a minimum loan amount you have to take out, subject to the lender’s own equity release rules.
On average the most amount of equity you can release using lifetime mortgages is around 60%, while you may be able to access a little more with a home reversion plan.
If you have a shorter life expectancy than expected, possibly because you have been diagnosed with a terminal illness, you might be able to access more home equity than standard. This is known as using an enhanced equity release scheme where your health is assessed through a questionnaire and proven by supplying the lender with your medical records. No additional medicals should be required as part of the application process.
By getting access to more money during this time, it could be used to fund private care and treatment or to tick off the things you want to see and do before you die.
Do you have to get financial advice first?
ERC members are told to ensure that potential borrowers have received advice before they get equity release. However, you should opt for independent financial advice rather than just using the advice given by a company offering lifetime mortgages.
Do you have to get independent legal advice?
Yes, as part of the equity release process you are also required to get independent legal advice too. Most people can get independent legal advice from the same company they receive financial advice, such as equity release specialist companies. They’ll also help you search for lifetime mortgages in the UK and compare options.
Can I release equity with bad credit history?
Even though you are not required to make monthly repayments after you get equity release, the lender will still complete a credit check to see if you have existing debts. If you have CCJs or a charging order, you are likely to be rejected for your equity release plan, unless the lender is able to use some of the money to clear your debts directly. If you have a bad credit history but have already paid back all arrears, there is no reason why you will not be able to get equity release.
Can you be rejected for equity release plans?
You can be rejected for equity release if you have CCJs on your credit file, but there are more common reasons why people get rejected for a lifetime mortgage.
You are more likely to get rejected for equity release if there are issues with the property. The most common reason is too great a percentage of the roof is flat, but other reasons include:
- The presence of asbestos
- Non-standard construction, possibly not built to regulations
- Single skin constructions
- Proximity to a commercial property
- High flood risks
The benefits of equity release schemes
Here are some of the reasons why seniors still consider taking out an equity release plan:
- The money can be given as a lump sum or drawdown
- It can be spent without restriction or even given away
- You do not need to make monthly payments, but you can volunteer to pay some of the interest off to keep the debt total lower
- You continue living in your home without having to pay rent and without the threat of being evicted in normal situations.
- As illustrated earlier, the ERC provides a tonne of additional benefits and assurances.
What are the pitfalls of equity release?
Before rushing into an equity release agreement, it’s essential that readers are aware of some potential pitfalls, such as:
- Releasing too much equity – releasing too much can significantly increase your total debt and can be avoided. If you are not sure how much you need to borrow for your purpose, consider a drawdown facility instead to avoid unnecessary overborrowing.
- Disclose all information with financial advisers – make sure to tell everything to your adviser so they source the best equity release loan for your circumstances. For example, downsizing in the future can mean paying back some of your loan and incurring early repayment charges. But knowing this in advance could mean getting an agreement that doesn’t incur costly fees when you downsize.
- Not using an ERC member – although it is not mandatory, using an ERC member to get your loan can be highly beneficial, and it is almost a mistake not to use these companies in many situations.
Is releasing equity the right option for you?
Equity release is more than a financial decision, it is a personal decision that considers your estate and who will inherit your wealth and assets. Speaking with an independent financial adviser is the best and only way of knowing if it is the right decision for you. They will not tell you what to do, but they will give you the facts so you can make an informed decision.
Does equity release get taxed?
Equity release doesn’t feel like a loan because the money is not paid back through monthly repayments. But it’s important to remember that it is a loan, and because it is a loan, the money is not subject to income tax or Capital Gains Tax. You will not have to pay tax on any of the money you receive.
But there can be consequences to the inheritance tax owed on your estate. By not passing on a complete property to a child or grandchild, you miss out on increasing your inheritance tax threshold by £150,000. On the flip side, by gifting the money from equity release away, that money will not be subject to inheritance tax at all as long as you remain alive for seven years from the date the money is given away.
Does equity release affect your state pension?
Equity release does not affect eligibility to receive a state pension because it is not a means-tested benefit. Only means-tested benefits can be affected if your cash wealth increases, i.e. if you now have a lot of savings you may not be allowed to receive state support.
Some people receive a pension top-up payment called pension credits. For every £500 they have in the bank above £10,000, they receive £1 less in pension credits. Having too much saved can wipe out any eligibility to receive pension credits. This is significant because without eligibility for pension credits, you can more easily lose eligibility to others, such as a council tax reduction.
An alternative option to equity release
If you want to leave the full value of your property as an inheritance for your family then using an equity release plan won’t be suitable. There is one good alternative that allows you to create a financial nest egg for retirement, while also leaving a complete property and its market value to family members.
Have you guessed it? The answer is to downsize.
By selling your home and moving into a less valuable home, you could create a financial pot and then still own 100% of a property that could be passed on, and it may have increased in value further when it is passed on.
Some negatives of doing this are the stress and costs involved when moving house, especially in older age. Or you and the rest of the family may have a sentimental attachment to your current home and not want to sell.
Discover more about releasing equity
This is just one of lots more equity release guides new to MoneyNerd. We’ve prioritised creating scores of equity release guides to answer the internet’s most asked questions on the subject. If you are starting to think about taking out a lifetime mortgage, we have more free content that will benefit you!