Pitfalls of Equity Release – What to Look Out For
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Anyone considering an equity release plan like a lifetime mortgage should also be aware of the pros, cons and potential pitfalls of equity release in the UK.
In this new MoneyNerd guide, we discuss the different equity release schemes before looking at the potential pitfalls of equity release. If you’re thinking about releasing equity, you need to hear this first!
What is equity release?
Equity release schemes are ways for older homeowners to access some of their home equity as a lump sum or drawdown. They release equity from their home but do not have to make any monthly repayments on the loan amount or any interest that could be added.
Instead of paying back the money through instalments over time, it is only repaid from the sale proceeds of the property when it is eventually sold after they die or move into residential care. This means the property must be sold to repay the debt after death (from the estate). However, if you move into long-term care, you will need to sell your home to repay the debt earlier at this point.
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How to qualify for equity release
An equity release plan is only available to older people who own their home with no (or very little) existing mortgage. The minimum age requirement for the different plans start from 55 but can be as high as 65. The youngest homeowner must meet the age requirement.
On top of being the right age and owning your home, the property must have a minimum value of around £75,000 and it must be your main residence, i.e. not a holiday home or an investment property.
An application for equity release will include someone coming to calculate the current value of your home and check the property is not at risk of flooding etc. The lender will not want to provide an equity release plan on a home that could significantly decrease in value.
What is the purpose of equity release?
The primary purpose of equity release is to provide older people with another retirement income. The money may be used to help live a more comfortable and enjoyable retirement, such as general living expenses, home improvements and even frequent holidays or cruises. If the homeowner is in ill health, it may be used to pay for private healthcare services to avoid needing to go into long-term care.
Some people decide to use the money as a gift to family, possibly to help them start a new business or get on the property ladder.
How does equity release work?
There are two main equity release schemes in the UK, and they are called a lifetime mortgage or a home reversion plan. There are some variations of a lifetime mortgage. Below we explain these two main types with an example to make it even clearer.
A lifetime mortgage allows the senior homeowner(s) to release equity and pay a fixed interest rate for the duration of the mortgage. However, just like how there are no loan repayments, there are also no interest payments to make. The interest accumulates over the span of the lifetime mortgage and adds to the total debt, known as compound interest.
For example, let’s imagine you have a £195,000 property and you want to release one-third of equity (side note, it’s usually only possible to release up to 60% of equity with a lifetime mortgage at max). You receive £65,000 as a cash lump sum. As part of this form of equity release, you agree to pay rolled-up interest of 6.4% on this amount. After 12 years, due to the rolling interest, your new total debt will be almost £137,000 – more than double what you took out.
It is possible to make voluntary interest repayments with most lenders. This will keep your total debt down. You should be able to see the true costs of a specific lifetime mortgage over time using an equity release calculator.
Home reversion scheme
A home reversion plan allows the homeowner to access some of their home equity as a lump sum or drawdown. The money taken out is not usually charged with any interest, but the homeowner must agree to give the lender a greater percentage of the sale proceeds in comparison to the amount of equity they release. They can be just as expensive or even more expensive than lifetime mortgages.
For example, you may ask the lender to release 20% equity in your £150,000 home. You then receive £30,000 and pay no interest on this loan. After so many years, you need to move into long-term care and the property needs to be sold. It is sold for £160,000 as it slightly increases in value. As part of the arrangement, you agreed to pay the lender 50% of the sale proceeds, meaning the debt paid back is £80,000.
Why does equity release have a bad reputation?
Historically, equity release had a bad reputation because it was seen as an expensive trap. Moreover, there were some lenders who were hard to deal with and made it difficult for homeowners to make any changes to their property once the equity release plan had been agreed upon.
Although equity release hasn’t gotten any cheaper, the good news is that the sector is a lot different today, especially due to the Equity Release Council, which will be discussed in detail shortly.
What are the benefits of equity release?
The main benefits of using an equity release plan are:
- The money can be received as a lump sum or drawdown. Using a drawdown lifetime mortgage can save you money if you don’t plan on spending it all at once because the interest is only charged on the amount you draw on.
- There are no monthly payments to make, but voluntary payments are usually possible to reduce the total debt.
- You continue to live in your home and do not have to pay rent.
- The money can be used for any purpose you wish. From new kitchens to cruises or paying off other debts, there are no restrictions.
- Equity release may not feel like a loan because there are no monthly repayments. But it really is a loan and that means it is tax-free. There may be inheritance tax implications – good or bad – from releasing equity this way.
What are the benefits of choosing an Equity Release Council lender?
There are some additional benefits of equity release that are guaranteed when you choose a lender that is a member of the Equity Release Council (ERC). The ERC is a voluntary membership group for all businesses working in the equity release industry, such as an equity release provider or a financial adviser company.
Every member must be authorised and regulated by the Financial Conduct Authority, and they must agree to the rules and guidelines set down by the council. These rules and guidelines have been made to offer homeowners greater protection when using any form of equity release but are most applicable to lifetime mortgages.
For example, if you choose an equity release company that is an ERC member, they must:
- Guarantee never to evict you for normal reasons – you’ll never be forced out of your home unless you commit fraud on the application or if you purposefully allow the property to go into disrepair.
- You’ll never owe more than what your home sells for – the negative equity guarantee ensures homeowners that they will bever have to pay back more than what their property sells for. This means any shortfall between a growing lifetime mortgage debt and the sale proceeds does not need to be paid by you, your estate or estate beneficiaries.
- You must be allowed to move home – the ERC state that homeowners must be allowed to move to suitable alternative properties and take their lifetime mortgage with them as long as the property is a suitable alternative. This means the property should be at least an equal value of your home currently and just as easy to sell in the future. Downsizing to a less valuable property is still possible, but you may need to pay some of the mortgage off first.
What are the negatives of equity release?
The predominant negative of equity release plans is how costly they can be or become. If you have a lifetime mortgage for over a decade and do not make any voluntary interest repayments, then the total debt can easily double even with a standard interest rate. This is why the negative equity guarantee is so beneficial.
The knock-on effect of using an equity release plan is that it significantly devalues your estate and what your estate beneficiaries will receive. This is one of the biggest factors people consider when thinking about using equity release. If your loved ones are relying on your estate for financial stability, you may decide to put their needs before your own.
Are there any pitfalls with equity release?
There are a number of potential pitfalls when using equity release. If you don’t avoid these pitfalls, you could make the wrong decision or make your plan more expensive than it could have been. We list three potential pitfalls below.
What are the pitfalls of equity release?
Three of the most common pitfalls of equity release are:
- Not choosing the right financial adviser – you could secure a better deal by using a financial adviser that specialises in equity release rather than a generic adviser who usually deals with other areas of finance.
- Not disclosing all information to your financial adviser – Failing to tell your adviser everything could be a costly mistake. For example, not telling them you want to downsize could mean getting the wrong agreement that triggers early repayment fees when you pay off part of your mortgage. Whereas the adviser may be able to get an agreement that does not trigger early repayment charges when you downsize.
- Releasing a bigger cash lump sum than what is needed – Accessing more money than you need is a pitfall because you’ll be stuck with debt on that amount. If you are unsure what you need then you could opt for equity release drawdown instead.
It could also be argued that not using a lender that is a member of the Equity Release Council could be a pitfall. This is because you may not receive the same guarantees and insurances as if you did.
How does equity release affect benefits?
Equity release can affect entitlement to means-tested benefits. If your new cash wealth puts you above the threshold to receive some benefits, you’ll not be entitled to receive them.
Seniors will never lose access to their state pension, but they can lose access to pension credit top-up payments. For every £500 above £10,000, your pension credit payment is reduced by £1. If you lose all access to pension credits, you might also lose access to a council tax reduction.
Moreover, anyone with savings above £16,000 cannot get Universal Credit.
What is the catch with equity release?
The main catch with equity release is the cost of the eventual debt. It’s important to use an equity release calculator and receive sound advice to understand the full costs.
Releasing equity when you are younger
Don’t confuse any of the above with borrowing against equity as a younger homeowner. These are called second charge mortgages, and you can read about them here.
Is equity release a good idea today?
Equity release can be a good or bad idea depending on individual circumstances. This is why it is mandatory to receive independent financial advice before making a decision.
Have another equity release question?
If you have any more questions about equity release, it’s almost certain we’ve answered it in one of our other guides. Read them soon!