What’s the catch with equity release?
If you are looking for a lump sum of cash, then you have probably considered taking equity release on your home. Whether it be to pay for a holiday, or to pay for home improvements, there are lots of reasons why you might suddenly want to get your hands on that money. But before you dive headfirst into this option, it is very important that you really think about it. Equity release is a big decision, and it definitely isn’t something that you should take lightly. In this guide, we’ll be taking a look at what that catch is.
The catch is the fact that the money that is released from your home will need to be repaid. You personally will not have to repay the money that is released. But upon your death, or when you move into long-term care, the money will have to be repaid. So, the catch doesn’t really fall on you, but it does fall upon your next of kin.
With a lifetime mortgage, the capital borrowed, along with the interest that has built up on it, will need to be repaid. In a home reversion plan, the reversion company will retain part/whole ownership of the property. However, home reversion plans are a lot less common than lifetime mortgages.
But, this isn’t the only catch when it comes to equity release. So, let’s take a look at some of the other things to consider when it comes to equity release.
What is Equity Release?
In short, equity release is an option which can be used by homeowners to release a lump sum of cash from their house, without having to move home. A lot of the time, equity release is sold as a stress and pain-free option, but there is actually a pretty big catch that comes with it. You have 2 options when it comes to equity release, they are a lifetime mortgage, and a home reversion plan. Both options allow you to get a lump sum, but the catch is different for each one.
To qualify for both options, you have to be a UK homeowner, have a mortgage/secured loan, and your home must be in good condition. For a lifetime mortgage, you have to be aged 55 or older, and for a home reversion plan you have to be aged 65+. As long as you fit these criteria, you will qualify for equity release.
What are the Pros and Cons of Equity Release?
Even though equity release comes with a catch, this is still a good option to consider. So, let’s take a look at some of the main pros and cons of equity release.
- You can get access to money that wasn’t liquid before, either in a lump sum or in smaller payments.
- If you choose a lifetime mortgage, you will retain ownership of your home, and still be able to live there.
- Equity release is transferable, so you will still be able to move in the future if you wish to.
- You end up borrowing more money than you need with a lifetime mortgage, even if you do not take monthly payments.
- The interest rate which you pay on your equity release usually increases as the money you borrow increases.
- With a home reversion plan, you give up ownership of a part-share, or all of your home to the reversion company.
Age and Lifetime Mortgages
As we said earlier, in order to qualify for a lifetime mortgage, you have to be over the age of 55. This isn’t strictly true. You can get equity release through a lifetime mortgage when you are younger than 55, but there is a catch. This catch is that there are mandatory payments upon this. Despite this, most people will only use a lifetime mortgage for equity release once they pass 55 years of age. But even being this age could affect you.
Typically speaking, the older you are, the more money you can borrow. Your age when you apply for equity release does not directly impact your interest rate, but it does affect the money that you can borrow, which in turn impacts your interest rate. This is partly because the equity release plan will last longer if you take it out when you are younger.
This isn’t necessarily a bad thing for you when you first take out the plan, especially if you are not making interest payments. But, the interest on the payments is rounded up and added to the repayment value that is owed when it passes onto your next of kin. So compound interest is something that you should be concerned about when considering equity release.
The Impact of Compound Interest on Equity
Another “catch” that comes with an interest payment-free lifetime mortgage is the compound interest itself. As we have already mentioned in relation to age, compound interest is the interest that is accrued upon the loan. The interest that will need to be repaid alongside the capital released.
When you choose to go through with equity release, the interest might not seem like a big deal. But over time, this can really accumulate. Especially if you had a bad interest rate to begin with. This even impacts fixed interest rates because the amount you have to pay will increase, even if the interest rate doesn’t. So, the amount that you eventually have to repay will be a lot higher than what you originally borrowed.
Early Repayment Charges (ERC’s)
As you can see, there are all sorts of potential catches that come with a lifetime mortgage. The next one that you need to be mindful of is early repayment charges. These are charges which you will be faced with if you were to repay the loan early. Most lenders will have a fixed penalty for doing this, and it will usually be a percentage of the repayment amount.
This could affect you if you had planned on taking equity release, then repaying the capital borrowed early. So, if this is something that you are thinking of doing, you should discuss it with your financial adviser before you take out equity release.
But, there are some exemptions for ERC’s, these include downsizing protection which allows you to repay the loan when you move house without incurring a penalty. So this is something else which you need to think about.
Other Catches to Avoid
Not Reviewing Your Finances
It is incredibly important to review your finances once you take out equity release to ensure you do not fall victim to the “set up and forget” catch. Interest rates constantly fluctuate, so if you are in a fixed interest rate lifetime mortgage, you could end up paying more money than you need to. So always review your finances.
Shared Appreciation Mortgages (SAMs)
SAMs mortgages were very short-lived, but they had a huge impact on equity release. In particular, the reputation of equity release. SAMs mortgages seemed too good to be true, and that’s because they were. With this type of mortgage, you could release up to 25% of your home’s value, and get this in a lump sum.
But the catch was that you had to repay a share of any increases in the property’s value at 3x the percentage borrowed. As house prices increased, this meant that some people who took out equity release in this form had to repay huge amounts, and in turn banks/lenders were making huge profits. This did a lot of damage to the reputation of equity release, but it is much better regulated today.
So, Is Equity release a good idea?
So, as you can see, there are quite a lot of potential catches when it comes to equity release. Due to this, it isn’t the best choice for everyone, and that is why it is so important that you seriously consider this option before you choose it.
If you want to get access to a lump sum, then equity release might seem like the only possible choice, but this isn’t the case. Here are just a handful of other options available to you:
- Down-sizing to a smaller home.
- Selling fixed assets.
- Research potential grants (especially if you want to make home improvements for health reasons)
Equity release might seem like the easiest option, but this shouldn’t be the only reason why you choose this. Before you choose equity release, you seriously need to consider everything we have told you in this guide, and seek legal and financial advice to see if this is the best option for you.
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We're trusted to manage over £190 million of our clients funds
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The unique PlanHappy Lifestyle Financial Planning process has been specifically designed to help you get what you want
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