There are few financial products available to ordinary individuals that have had quite the bad press that equity release has had over the years. Despite this you still hear it being discussed as a viable option for retirees, so what gives?
Basically equity release is a fairer, more transparent and, crucially, a more affordable option than it used to be. It is also now regulated by the Financial Conduct Authority (FCA) and the industry is led by the Equity Release Council.
These days the most common form of equity release is the so-called lifetime mortgage. The key thing is that under such an arrangement the equity release provider doesn’t take a share of your home as used to happen in the bad old days. You merely have a mortgage secured against your property. This means that, as with a traditional mortgage, you still benefit from 100% of any capital appreciation that occurs after you have taken the loan.
However, unlike a traditional mortgage, you neither make any repayments of the original loan, nor do you pay interest. The mortgage is settled from your estate when you die and the interest is simply rolled into the loan during your lifetime.
The interest rate (as of January 2018) could be as low as 3.75% for a fixed rate deal which lasts for the term of the mortgage. This is a far cry from the 7% or even 9% that was not uncommon just a few years ago. As a guide, if the rate is 7% the size of the debt will double every 10 years.
So let’s look at a little example.
Brian and Rachel are both in their seventies and have a home worth £300,000 with no outstanding mortgage. They aren’t keen to downsize just yet (which, of course, is another way of getting at the equity in you main residence). However, they would like to be able to have more money to spend in their retirement.
One feature that would particularly help Brian and Rachel is that the proceeds from today’s lifetime mortgages don’t even have to be drawn down all at once. You can take what you need, when you need it, so you only pay interest on what you have actually drawn.
Being in their seventies the most that the couple can typically borrow is likely to be around 40% of the value of the property: in this case £120,000.
If we assume the 3.75% fixed rate from above, then the size of the loan will have risen to around £175,000 after 10 years (depending on how exactly the interest is calculated).
At the same time, however, the value of their house could easily have risen at the same annual rate, which would mean it was now worth almost £435,000. That being the case their equity would still be around £260,000, despite having withdrawn £120,000.
Those are the pros, but there are always cons
- The first is that it is still possible to face high fees if, for any reason, you need to redeem your mortgage early. This is the same as with a conventional fixed rate mortgage. Basically there is usually a lock in period. One provider I’ve seen also charges a completion fee of £1,295, which is not untypical for the sector. You may also have to pay solicitor’s fees and for a valuation.
- The second issue is that drawing any equity from your home is tax free, but still might affect any means-tested benefits you are receiving.
In general however, equity release is one way of supplementing your savings in retirement. However, because of the costs involved, it should probably be regarded as last resort, or safety cushion, rather than part of your basic retirement plan.
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One alternative might be an informal equity release arrangement with a family member, particularly if that family member stands to benefit from your estate after you have died.
They could make a loan to you against the value of your house. The value of the loan (plus the rolled up interest) could be offset against the value of your estate in assessing inheritance tax. Your potential beneficiary could therefore reduce the IHT bill on your estate, plus receive a decent rate of interest on their savings.
This is something that is best formalised with a solicitor, but might avoid heavy fees, as well as retaining the interest accumulated within the family.
Some other issues you might also want to consider before deciding on equity release:
- Is it feasible to live in the house into old age?
- Is anyone living in the house currently likely to need care anytime soon?
Both of these issues might mean that a long-term commitment to a lifetime mortgage would be unsuitable.
The equity release council is an industry association, so can hardly be expected to be too critical. Nevertheless, its Frequently Asked Questions section is well worth a read if you are considering releasing equity from your home.
Take care out there