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Interest Only Equity Release? All you Need to Know 2022

interest-only equity release

For free and impartial money advice and guidance, visit MoneyHelper, to help you make the most of your money.

What is interest only equity release and is it worthwhile? 

There is a way to keep the growing costs of a lifetime mortgage down by choosing an interest-only lifetime mortgage instead. These interest-only mortgages may or may not be a wise financial decision. 

Read on to learn about the interest-only equity release mortgage and related topics. 

What is equity release?

Home equity is the value of your home that you own outright. So, if you have a £100,000 home and have an outstanding £10,000 mortgage, you have 90% home equity in your property and those who have paid off their mortgage already have 100% home equity. 

Some senior homeowners who own 100% of their home can access some of their home equity as a cash lump sum or drawdown facility without having to make any monthly repayments. Instead of repaying the loan back each month, they repay the money back when their home is sold, which may not be until after death.

Usually, the only time you can be forced to sell your home and repay the debt is if you have moved into long-term care and are no longer living there. 

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What is the purpose of equity release?

The idea behind equity release for seniors is to provide them with money in later life as a form of retirement income, which can be used for an array of unrestricted purposes.

Many use the money to live more comfortably over their retirement years such as paying for private at-home care, whereas others use it to improve their property, go on luxury cruises or help family members out with financing first-home purchases. 

The decision to use equity release or not is often not just a financial decision. Taking an equity release plan can be costly and eat away at the value of the estate you leave behind. Thus, you’ll probably want to consider the wealth of your estate beneficiaries before making a decision. 

Do you pay interest on releasing equity?

The most common method of equity release is a lifetime mortgage. When you take out a lifetime mortgage, the amount you release is subject to interest. The interest rate charged is usually fixed for the entirety of the lifetime mortgage. 

We discuss lifetime mortgages in detail shortly. 

Who is eligible for equity release?

To qualify for equity release, the youngest homeowner must meet a minimum age requirement, which is set somewhere between 55 and 65 years old. There usually must be no existing mortgage to pay on the property and it must also meet a minimum valuation, typically around £75,000. 

The property will also be assessed by the lender to ensure it meets regulations and will be simple to sell on the property market in the future. 

How does equity release work?

There are two main types of equity release schemes in the UK. These are the slightly less common home reversion schemes, and the more popular lifetime mortgages. 

You should only consider either of these equity release plans from a company that is authorised and regulated by the Financial Conduct Authority. Moreover, you should also seek out Equity Release Council lenders to give yourself more assurances and greater protection. 

Home reversion schemes

A home reversion scheme allows the senior to access up to 80% of their home equity at best. In return, the homeowner must agree to give the lender a greater percentage of the property’s sale proceeds in the future. 

For example, you might release 15% of a £200,000 home (£30,000) and be asked to repay 40% when it is sold (£80,000 unless it goes up or down in value by the time it sells). No additional interest is usually charged and the money can be provided as a lump sum or drawdown. 

Lifetime mortgage

A lifetime mortgage allows the homeowner to access some of their home equity as well, but it is usually capped at around 60%. Instead of simply paying back a greater percentage of the future sale proceeds, the homeowner commits to a fixed interest rate. This interest does not need to be paid back through monthly payments just like the principal amount doesn’t. Instead, the interest debt builds up and adds to the total debt repayable when the home is sold.

For example, you might have a £130,000 home and release £65,000 with an interest rate of 6.4%. After 12 years you move into long-term care and are required to sell the property as per the agreement. By this time, your interest will have rolled up to create a debt worth just under £137,000. Your home held its value during this time.

As you can see, there is a shortfall between the sale proceeds and the total debt owed. By using a lender that is a member of the Equity Release Council, a negative equity guarantee ensures any debt above the sale value does not need to be repaid. 

What is an interest-only lifetime mortgage?

Lifetime mortgages can be found with slight variations. One variation is an interest-only lifetime mortgage, also known as a retirement interest-only mortgage. 

An interest-only lifetime mortgage works in the same way as described above, but the homeowner commits to making monthly interest payments for as long as they live in their home. 

By making monthly interest payments across the lifetime of the mortgage deal, the amount owed from the eventual sale proceeds will always be the same as the amount taken out in the beginning. 

An interest-only lifetime mortgage is a good way to ensure the majority of your property value gets passed on to loved ones when you die, which is unlikely if you do not make monthly payments to clear the interest. However, you will need to prove that you can keep up with the monthly payments of interest. Sometimes the lender will allow you to stop making interest payments and allow the debt to grow as per a standard lifetime mortgage. 

How much do I have to repay monthly with an interest-only lifetime mortgage?

Most lenders grant the homeowner complete control over the amount of interest they repay each month. Many choose to make full monthly payments to clear the interest to maintain a level of lifetime mortgage debt. However, others choose to repay a smaller amount of interest each month.

Because the Financial Conduct Authority decided that no affordability checks are required on voluntary interest repayments, it is only right that the homeowner has the power to reduce or stop making these repayments. 

What is the interest rate on equity release?

The lowest lifetime mortgage and retirement interest-only mortgage rates are set between 3% and 8%. However, this is subject to change. 

When you search for a lifetime mortgage with your financial adviser they may show you an equity release calculator that projects your total debt over different time periods. These projections can be manipulated by making monthly repayments on the interest or not. 

Should I pay interest during my lifetime mortgage?

There may be arguments for and against using an interest-only lifetime mortgage over standard lifetime mortgages. Ultimately, a financial adviser should assess your specific situation to make a recommendation. Opt for an independent adviser who is regulated by the Financial Conduct Authority. 

By making interest repayments, you are keeping your total debt down and safeguarding more of your home’s value when it comes to being sold, which could significantly increase the amount you pass on to loved ones. 

If your debt has already grown to an equal level of the property value, it will not be worth starting to make interest payments if you are covered by the negative equity guarantee. As you cannot be made to pay any debt above the sale proceeds, repaying the interest would not be financially advantageous as the debt would only remain the same – not go down. 

If you do not have anyone to pass your estate to, then making interest repayments may not be worthwhile at all. As your home cannot be repossessed if you don’t make repayments, making them is not likely to offer a substantial benefit unless you end up moving into care with no savings remaining. This is best discussed with an equity release adviser. 

What are the advantages of interest-only lifetime mortgages?

The benefits of choosing an interest-only equity release are:

  1. The money you receive is not taxed.
  2. You can receive it as a lump sum.
  3. It can be spent on anything you prefer.
  4. You continue living at home and are not asked to sell unless you move into long-term care.
  5. You can pay off some of the debt to pass on more of your property value to loved ones.
  6. You have control over interest repayments. 

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What are the disadvantages of interest-only lifetime mortgages?

The disadvantages of an interest-only mortgage of this kind are:

  1. Interest-only lifetime mortgages are still expensive if you don’t continually pay 100% of the interest each month. 
  2. Using them will reduce the inheritance you pass on regardless of making interest payments. 
  3. You could stop being eligible for means-tested state benefits. 
  4. Missing interest payments or underpaying can quickly cause your total debt to grow.

Related FAQs

What is an interest-only equity loan?

An interest-only mortgage used to release equity, also called an interest-only equity loan, is a loan secured against your home. It is exclusively available to people over 55 years old to help make retirement more financially comfortable. 

The senior homeowner does not need to make repayments on the principal loan amount, i.e. the amount they borrow. But they are required to make interest repayments each month to maintain the same debt they start the loan with. 

The principal loan amount is repaid from the eventual sale of the property, which comes when the homeowner moves into long-term care, or after death from their estate. 

Can you get an interest-only mortgage?

To qualify for an interest-only mortgage, the youngest homeowner must meet the lender’s minimum age requirement. For these types of equity release plans, the usual minimum age is set at 55. If one of the homeowners is younger than 55, it is best to wait for them to meet the age requirement. Taking their name off the ownership documents of the home to access these plans earlier can be dangerous. 

As well as meeting this age requirement, the home must have a minimum value set by each lender. For the most part, the minimum value is around £70,000. And lastly, the home that you want to get an interest-only mortgage on must be your main residence rather than a holiday home or rental investment. 

Can I still obtain a mortgage in retirement?

You will not be able to obtain a standard residential mortgage to buy a home once you hit retirement. The only mortgage that tends to be available to people in retirement is a retirement interest-only mortgage, used to release equity from a property that is already owned with or without a small first charge mortgage. 

Are means-tested benefits affected by equity release?

Taking out an equity release plan can affect entitlement to some means-tested benefits. This is because releasing equity significantly increases your immediate savings until the money is spent, and can therefore put your savings amount above the threshold to qualify for those benefits. 

Your new savings will not affect your entitlement to receive a state pension, but it can wipe out or reduce your entitlement to pension credits. If you can no longer receive pension credits, there is a good chance you won’t be allowed to claim a council tax reduction as well. 

Learn more about interest-only equity release!

For more details about a retirement interest-only mortgage or related topics, stay tuned to MoneyNerd. We’ve just put fingertips to keyboard on 100+ equity release topics that are completely free to read. 

If you want to know about the details and intricacies of equity release in the UK, you found the right place to start. 

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