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How Does Equity Release Work

How does equity release work? If you have heard of equity release before but aren’t entirely sure what it is or how it works, this guide is for you. 

We’ve written a concise guide covering all aspects of equity release. Whether you want to know more about a lifetime mortgage, home reversion scheme or have related questions, you’ll find answers below.

What is equity release?

Equity release is when you extract cash from some of the value of your home as a lump sum in later life, usually to spend on retirement. You can continue living in your home after you have received the money. There is more than one form of equity release, meaning the finer details can differ between equity release schemes. 

You will need to be older than 55 to use an equity release scheme in the UK. It is a big decision to release equity; it’s highly recommended that you speak to an equity release adviser and refer to the Equity Release Council before making a decision. 

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Is equity release paid back?

Equity release has to be paid back and should be viewed as a type of loan secured against a percentage of your home. Equity release schemes only require you to pay back the money once you die, meaning it comes out of your estate which may require the property to be sold to raise funds for the repayments. You would need to pay the full amount back early if you sell the home and move into aged care. 

Some equity release plans will charge interest. The amount of interest builds up and is added to the total amount owed from your estate upon death. Some people choose to pay off the interest while still alive to mitigate the amount owed from their estate.

How exactly does equity release work?

Equity release works by securing your home with new debt. The lender gives you a loan as a lump sum and it is repaid when your house is sold, usually from your estate when you die or if you sell the property to go into long term care. 

There are two types of equity release products in the UK, namely:

  1. Lifetime mortgages
  2. Home reversion plan

To uncover which type of equity release is right for you, it’s best we tell you some more… 

The two types of equity release

We explain home lifetime mortgages and home reversion schemes work below. Can you spot the main differences?

  1. Home reversion plan

Home reversion schemes are available through some equity release companies. The company offers to buy a percentage or all of your property but you can stay in your home as a tenant who never pays rent. The lender will wait until you die or sell the property to go into care to get its hands on the money from the property. 

However, because the equity release company will not be able to access the money from the value of your home for a long time until it is sold – possibly decades – they make very unattractive offers. For example, a 25% advance could require you to surrender 75% of the value of your home. 

You’re usually only able to access between 20% or 60% of the equity from your home because the lender is taking a risk that your property does not decline in value and because of the time it can take for them to be allowed to sell the property. Your health and the home’s current value will determine how much you can borrow rather than your finances or credit score. 

  1. Lifetime mortgage

Lifetime mortgages are a far more popular form of equity release scheme in the UK. 

It is a mortgage for a proportion of the value of your home and comes with a fixed interest rate. It gives you a tax-free lump sum to be used as you prefer while you keep living in the property. 

The main difference from any other mortgage is that no regular repayments need to be made and the interest is rolled up, which essentially means it constantly gets added to the total debt owed. 

The total mortgage debt only has to be repaid when you sell the home, which is often when the homeowners die or move into care. A lifetime mortgage has the benefit of protecting you against negative equity, also known as the negative equity guarantee. This means the total debt can never be more than the value of your property. 

A lifetime mortgage lender will usually allow the homeowner to pay off some of the interest over time. This will reduce the lump sum debt owed upon death and allow more of the home’s sale proceeds to be passed on to beneficiaries of your estate. 

How do you qualify for equity release?

To qualify for a home reversion equity release scheme or a lifetime mortgage, the property must be your main residence. And you will usually need to be at least 55 years old. If two people own the home and want to release equity, the youngest person out of the two will need to be of minimum age to release equity. 

For example, if the age requirement is 55 and one person is 57 and the other is 53, equity release will not be possible until the 53-year-old reaches the age of 55. Some lenders may require you to be 60 to release equity. 

Other criteria to qualify for equity release are that your home is located in the UK and that the property has a minimum value, typically around £70,000 but it could be higher. 

What if I still have a mortgage?

If you still have a residential mortgage on your property or any other loan secured by your home, this will need to be repaid before you release equity. An equity release lender requires itself to be the first charge on the property. 

However, you can sometimes use some of the money from your equity release to pay off a small existing first charge mortgage as part of the equity release agreement. You’ll need to find applicable lenders if this is your plan. 

Am I protected when using equity release?

You are protected when using legal lifetime mortgage providers. When you enter into a lifetime mortgage from a lender that is governed by the Equity Release Council, the mortgage comes with an equity release guarantee.

So, what is the equity release guarantee? It is a guarantee that you will never go into negative equity, which is when you owe more money than what the property is worth. For example, if your property declined in value while your interest kept growing – adding to the total debt – the amount owed when you die would be more than what the property value and what it is sold for. This could mean more money is required to pay off the equity release provider, possibly coming from your estate.

But with the equity release guarantee, you are ensured that the amount owed when you die will not exceed the market value of the property and what it is sold for. If there is any shortfall at all, this will not have to be paid from your estate or by your estate beneficiaries. In this regard, you are well protected when using an equity release product. 

Why do people choose equity release?

The main reason someone in their twilight years will choose a lifetime mortgage or home reversion scheme is to make retirement more comfortable. 

The lump-sum could be used to help an individual or couple get the most out of retirement or to tick things off their bucket list, such as multiple trips overseas. Or it may simply be used to help the person overcome financial difficulties in their older years, such as paying off debts.

Some others choose a lifetime mortgage to access money to help out younger family members with their own finances and to buy a new property. This is possible, but it also means they will pass on less money within any inheritance. 

Can you lose your house with equity release?

You might have been warned against using an equity release scheme because “you can lose your house”. However, for the most part, this is not true. 

You will never be evicted from your house after taking out a lifetime mortgage as long as the lifetime mortgage was provided to you by a lender that is governed by the Equity Release Council. The property will remain yours to use as you always have done in any circumstance and you won’t be evicted. 

How much do you pay back on equity release?

The amount you pay back after taking out a lifetime mortgage will depend on:

  1. The fixed interest rate you agree to
  2. How long passes between taking it out and the time you die or move into long-term care
  3. And whether or not you decide to make monthly interest repayments while you are still alive and continue to live in your home

To understand how much you might have to pay back using a lifetime mortgage, we’ve created an example. If you took out one of these mortgages for £65,000 at a fixed interest rate of 6.4%, the total amount needed to be repaid after just 12 years is close to £137,000 – more than double the amount you received!

However, there is a cap on how much you pay back when the equity release guarantee applies, as discussed earlier. You won’t ever owe more than the amount raised through the sale of your home. This means if the interest increases the amount you owe beyond the property’s value, you’ll still only need to pay the money raised from the sale. 

The benefits of equity release

There are a number of benefits when deciding to release equity from your home. The greatest pros are:

  1. You receive a lump sum or ongoing payment that is not subject to income tax or Capital Gains Tax (CGT)
  2. The money can be used to make retirement more enjoyable or clear debts hanging over you in later life
  3. You can continue to live in your home without protest
  4. It’s still possible to pass on some of your property value to loved ones
  5. You can choose to never make any interest payments
  6. Or you can choose to make interest payments to increase your estate
  7. There are a number of providers to consider

What is the downside to equity release?

The major downside of either form of equity release product is that the money you are paid is significantly below the real value of your asset. Home reversions schemes offer low amounts to protect themselves against a property declining in value and not profiting from the scheme themselves. Whereas lifetime mortgage providers offer low amounts for similar reasons, as well as the repayment cap from the aforementioned equity release guarantee. 

It can also be exceptionally difficult and costly to leave a lifetime mortgage so once you have made the decision, it’s rare that you can reverse your decision. There are also an exceptional number of equity release horror stories, so it’s worth reading through some to clue yourself up.

What is the catch with equity release?

There is no catch with equity release as long as you fully understand how these schemes work. Some people believe the catch is that you are low-balled an offer, but there are legitimate reasons why lenders do this or they could lose money themselves. Others think the catch is that you have to pay the money back, but if you didn’t have to, equity release would just be free money. 

Is releasing equity the right option for you?

Only you can decide if releasing equity is the best decision for you. However, you should make that decision with all of the facts and potential pitfalls explained in full. It’s highly recommended to access financial advice services from an independent financial adviser before making a decision. Only choose a service that is authorised and regulated by the Financial Conduct Authority (FCA). 

You might also want to speak with your family and any other estate beneficiaries about your plans. Most people seek approval from family members before making any moves, although this of course is not a requirement and you can make the decision without informing a beneficiary. 

Keep chewing the fat on equity release!

This guide should help anyone asking the question “how does equity release work?”. But we understand that you might have many more questions and queries about equity release. 

That’s why MoneyNerd has just published scores of other articles and guides discussing other aspects of equity release and related FAQs. And they are all free and available right now – check them out! 

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