Equity Release In Depth

At its most basic level the main purpose of an equity release product is to enable you to borrow money based on the value of your home and use your home as security for the debt. You can release 'equity' from your home without having to sell it and move out. The term 'equity' is used to describe the difference between the market value of the house and the mortgage amount.

Equity Release Council (ERC)

The Equity Release Council (Formally known as The Safe Home Income Plan (SHIP) organisation) is an industry body which was set up in 1991 and is dedicated to the protection of plan holders and the promotion of safe home income and equity release plans. In addition to providing fair, simple and complete presentation of their plans, all participating companies pledge to observe the Code of Practice. This means that they must:

• Ensure that the plan-holder retains the right to live in the property for as long as they wish.
• Grant the right to move to a suitable alternative home without penalty.
• Insist that the plan-holder appoints their own Solicitor who must certify that they have explained all the conditions of the loan before the provider will release any money.
• Guarantees that the plan-holder cannot lose their home, irrespective of what happens to the stock market or interest rates.
• Carry a 'no-negative equity' guarantee
• The Equity Release Council certificate will clearly state the main cost to the householder's assets and estate e.g. how the loan amount will change, or whether part or all of the property is being sold.

ERC also provides a formal procedure for handling complaints.

The fact that all members must carry the 'no negative equity' guarantee means that schemes that offer this guarantee will never take any more than the value of the home. Therefore, if the value of your home has fallen below that of the loan amount, your estate will not have to make up the difference. You or your estate will only repay the market value of the house.

The following is an outline of the main schemes, along with the pros and cons of each:

Lifetime Mortgages

With a lifetime mortgage a lender will make a loan to you and your home will be used as security. This means that the lender has certain legal rights and you have certain legal obligations to fulfil.

Similarities to standard mortgages:

• A first charge will be taken on your property
• Your property is therefore used as security for the loan.
• There are a range of interest rate options that will apply to the mortgage, including standard variable, discounted, tracker, deferred, fixed, capped, capped and collared and stepped.

Main differences to standard mortgages:

• Usually aimed at older clients', typically over 55
• There is no specified term
• There is normally no fixed regular repayment
• The loan is usually repaid out of your estate - some lifetime mortgages however provide for repayment of the loan on a regular basis, rather than on death or if you move out of the property.

Lenders rights and borrowers obligations usually include:

• Maintenance and repair of the property.
• Right of the lender to inspect the property subject to reasonable notice.
• Lenders right to carry out repairs and charge them to the account of the customer.

The main types of lifetime mortgages together with a summary of the key pros and cons are:

Home income plans

Designed to release equity, you take out an interest-only mortgage against your home and usually use the capital raised to invest in a long term insurance product/investment to provide a monthly income. In most cases an annuity is purchased, providing a guaranteed income for life. Part of the annuity income is used to pay the interest on the mortgage and the capital borrowed is usually repaid from the proceeds of the sale of the home on death, or if you move out of it (perhaps into a care home) then the scheme will end and the home will be sold.

Pros

• An annuity is a safe and guaranteed way of providing an income.
• There may be a possibility to take a lump sum in addition to an annuity.
• The older you are, the higher the income.
• It pays a regular income for life and the mortgage interest is deducted automatically.
• The amount owed is fixed and any increase in the value of the home belongs to you.

Cons

• Not suitable for those looking for a substantial lump sum.
• Income is normally fixed at outset, in which case it will be eroded by inflation.
• The younger you are, the lower the income.
• Establishing affordability is important because of the need to maintain the interest repayments.

'Roll Up' plans

Designed to release equity, the lender pays a lump sum or income, or both, but there is no requirement to purchase a long term investment product such as an annuity. This is because you do not need to make any repayments during your lifetime and, instead, the interest is 'rolled up' into the loan. Lump sums can be used for any purpose (such as paying for holidays) and where a lump sum only is released, these are often referred to as 'cash schemes'. The mortgage is usually repaid from the proceeds of the sale of the home on death, or if you move out of it (perhaps into a care home), then the scheme will end and the home will be sold.

Pros

• A cash lump sum is received which you can decide how to spend or invest.
• No interest is payable until you die or move into residential care, so you will receive a higher income for the same sized loan compared to a home income plan.
• The older you are, the higher the 'loan to value' will be.
• Many loans are fixed interest - hence reducing risk.
• Flexible drawdown schemes allow you to control how quickly the debt builds up (because interest is only charged on the amounts drawn down).

Cons

• There is uncertainty about how much will have to be repaid at the end of the plan and how much will be left for your family.
• Interest payments can mount up quickly and significantly reduce what your family will inherit. Your family could end up with nothing from the sale proceeds even though the lump sum received only seemed a fairly small proportion of the home's value.
• As the interest is not paid off before you die (or move into residential care), the interest rate tends to be higher than for ordinary mortgages.
• The younger you are, the lower the 'loan to value' will be.
• A 'top-up' loan may not be available later.

Shared appreciation mortgages

Also designed to release equity, but the lender takes a share of the capital appreciation in addition to the original loan which must be repaid on the death of the borrower, or earlier sale of the property. The cash released can usually be used for any purpose.

Pros

• No regular repayments to make.
• The loan could end up costing nothing if the home's value has not increased, or if it has actually fallen in value.

Cons

• If house prices rise strongly the effective cost of the loan could be very high.
• If you need to move home in the future after a period of strongly rising house prices, you may find that you can only afford a much smaller/cheaper property.

Flexible Drawdown plans

This is simply a variation of a Lifetime Mortgage which allows you to set up an agreed maximum facility for a specified period (based on your age and house value), but take just as much as you want initially subject to a minimum (which varies between providers) and take further money (up to the maximum agreed facility) when required.

This helps save the debt building up as fast as interest is only charged on the amount actually outstanding at any one time. Some schemes may also allow voluntary partial repayments to reduce the debt in the first five years without penalty.

Pros

• Withdrawals can be taken as and when required, or monthly payments can provide a regular income.
• Interest is only paid on the amount drawn down so interest will accumulate more slowly.
• Greater control of your own money.

Cons

• Interest rates can be higher than under other lifetime mortgages because of the added flexibility.
• If you want to increase the cash amount beyond the original amount agreed at outset or continue with the drawdown facility for longer than the agreed terms (say 10 years) you will have to apply for a further advance which might not be available.
• There are restrictions on the minimum amounts that can be withdrawn.
• Inflation could erode the value of cash over time (the maximum that can be drawn down is set at outset although the actual amounts drawn could be spread over potentially many years).

Home Reversion Schemes

Home reversion schemes are not mortgages; instead all or part of the property is sold in return for a cash lump sum, a regular income, or both. It is usual to get between 35% and 60% of the market value of the house - the older you are at the start of the scheme the higher the percentage that can be obtained. This reflects the fact that you cannot sell the property until you die or move into care. You obtain the right to continue to live in the house under a lease, the terms of which will vary depending on which reversion scheme is chosen. A nominal rent is usually paid each month (e.g. £1), or there may be a choice of paying a higher rent in return for more money from the sale.

Home reversion schemes should be considered as an alternative to lifetime mortgages and, since 6 April 2007, they have also been regulated by the Financial Conduct Authority.

Pros

• No ongoing repayments to make. The reversion company makes all of its money when the property is sold (i.e. on death or earlier sale).
• You know at outset what share of your home (if not its value) you will be leaving to your family.
• You will continue to share in any rise in the value of the property (unless you have sold its entire value).
• Unless the maximum is taken at the outset, you should be able to sell further percentages when required. This means that you should be able to raise further funds to improve your finances, pay for long term care or even mitigate Inheritance Tax. Further releases are unlikely under Lifetime Mortgages unless the home increases in value by more than the loan increased with the compounding of interest.
• Smokers or those with an impaired life may be able to receive a larger payment.

Cons

• The reversion company will buy at a discount to the current market value. The big discount at which the reversion company will want to buy makes these schemes less suitable for people in their 60s and those with low value properties.
• If death occurs soon after taking out a plan, you could have effectively sold your house (or a share of it) on the cheap. Some schemes will however give families a rebate if you die within the first few years of signing up.
• Ownership of the property is lost but you remain responsible for the upkeep of the property.
• Reversion companies can be choosy about the properties they take.
• Reversion schemes are available from several different providers, but the details and terms vary. For example, apart from the amounts each company deducts converting your share into a benefit; some schemes allow you to benefit from increases in property values while others do not. In addition, some schemes will allow you to sell 100% of your property, whilst others may limit it to only 90%.
• It is unlikely the portion sold could be bought back.

Lifetime Leases

A recent development in the equity release market is the introduction of a Lifetime Lease. The key features of the product are:

• You must be aged 65 or over.
• You find a property that you want to move to either with or without the assistance of the company. The new property is owned by the company, who provides you with a lifetime lease enabling you (and your partner if applicable) to live in the property for the rest of your life.
• The lifetime lease is rent-free therefore you do not pay any rent.
• You pay to the company a discounted amount of the value of the new property - typically between 47% and 76% of its market value, to purchase the lifetime lease. The amount of the discount depends on your age, gender and marital status. The older you are the greater the discount.
• You obtain the capital you require by retaining the difference between the capital received from your existing home and the discounted price paid to the company for the new property, less cost of fees.
• The company may offer a free home search, help with purchasing the new property and may purchase the existing property, based on two independent surveys.
• You can move to another property in the future, but may incur additional costs on the lease if the property is of greater value than the one you are in. You will also be responsible for stamp duty, legal fees and estate agent fees etc.
• Responsibility for the maintenance of the property and the buildings and contents insurance remains with you.

It is important to note that unlike Lifetime Mortgages and Home Reversion Schemes, Lifetime Leases are not currently regulated. This option involves you obtaining a capital lump sum and therefore eligibility for certain State Benefits may be affected.

This is a lifetime mortgage plan.  To understand the features and risks, ask for a personalised illustration.

If you take out an equity release plan too early in life, you may not have enough value left in your home to move to a property later on 

Using equity in your home will affect the amount you are able to leave as an inheritance

State benefits may be affected by any equity released

Taking out an equity release scheme will affect you in the short and long term. You need to be sure you are happy with the scheme now and that it will suit your objectives now and in the future as far as you are able to judge.