Given the extraordinary house price inflation over the last decade, you’d be forgiven for thinking that your home will be enough to fund a long retirement. These days, owning a semi in Penge can make you a millionaire, at least on paper. But is property a reliable investment? And can it really provide you with a pension through equity release? You might think you can use your home like an ATM, but it might have serious implications.
In this post, I’ll outline how equity release works, explain some of the pros and cons, and help you decide whether it’s right for you.
What is equity release?
Equity release allows you to access cash based on the value of your property while remaining in your home. It’s grown in popularity recently, now that so many of us are sitting on valuable assets but lack disposable income. Most schemes are available to people aged 55+ and provide them with a tax-free lump sum. The amount you can borrow depends on the value of your property, your age, and your health.
There are two main types of equity release scheme:
This type is the easiest to understand. You borrow a proportion of your home’s value and pay it back with interest. Just like a traditional mortgage. The main difference, though, is that you usually only pay back the loan and interest when you die or sell your home. Although that means you have no financial commitments, the interest can build up rapidly. You’re not paying off the principal of your loan (the amount you originally borrowed), only the interest. Therefore, the amount never reduces.
If you’re familiar with compound interest, you’ll know that seemingly small amounts balloon over time. This benefits us with savings and investments but works against us with loans. For example, if you borrowed £40,000 at 5%, the amount you owe would double every 15 years. Aged 75, you’d have a debt of £80,000; when you reach 90, it would be £160,000. This is because you’re paying interest on the interest. That might not matter if you have no dependents or other financial responsibilities, but it might come as a nasty surprise to your family. You could end up in a situation where the entire value of the property is owed to your equity release provider.
It’s important to check whether any scheme you’re considering allows you to get into negative equity. This is a situation where your outstanding loan is greater than the value of your property. Based on the example above, this could easily happen if you release equity at 55 and lived till you were 90. Also look carefully at interest rates and charges. Mortgage rates are currently at a historic low, but rates tend to be higher for equity release. As with traditional mortgages, you’ll also have to pay application, valuation, and legal fees. Make sure you understand exactly what’s involved.
Some lifetime mortgages allow you to repay some or all the interest each month. That helps you avoid the compounding effect.
So, the main points to consider:
- What’s the interest rate? How does this compare with a traditional mortgage? Could you remortgage instead?
- How much will you pay in application, legal, and valuation fees? Is this disproportionate to the amount you’re borrowing?
- Could you get into negative equity?
- Will the money you’ve released affect any means-tested benefits?
- Can you draw down money from the scheme? This means you access funds when you need them, rather than taking one large sum. You then pay less interest.
Home Reversion Schemes
These schemes are less familiar than lifetime mortgages and have potentially bigger implications. With a home reversion scheme, you sell a share of your property for less than the current market value – usually between 35-60%, depending on your age1 and health. You get to stay in your home and pay no interest. Effectively, you’re trading some of your equity for the right to live rent-free. And you transfer the deeds of ownership to the scheme provider. When you die or move into long-term care, your lender gets that share of your property’s value.
Let’s look at an example.
You own a house worth £500,000 and sell a 50% share to a home reversion scheme for £125,000.2 Twenty years later, you move into long-term care and the house is sold for £750,000. Your lender gets £375,000, as they own half the property.
As you can see, this has a big impact on your estate. Some providers allow you to protect a specific percentage for your beneficiaries. Otherwise, this could prove a shock for anyone expecting an inheritance. Perhaps you don’t want to leave them anything – after all, your priority should be ensuring you have enough to live on – but it’s a good idea to be open about your intentions.
There are also implications while you’re still living. Even though you have security of tenure, the home reversion scheme owns your property and you become a tenant. You would need to get their permission to make any substantial changes to your home, such as adding an accessible bathroom, and there could be restrictions on selling it and moving to a different property. You’re relinquishing control in return for that tax-free lump sum.
If you think a home reversion scheme is suitable for you, here are a few issues to consider:
- Are you allowed to transfer the scheme to a different property?
- How much will you pay in legal, valuation, and application fees?
- Do you have any other debts secured on your property?
- Will the money you’ve released affect any means-tested benefits?
- If you have a family, do they understand the implications of the scheme?
Equity release is a relatively recent concept and there are lots of new operators entering the marketplace all the time. Naturally, some are more reputable than others. Always check that the provider you’re considering is a member of the Equity Release Council. This means they’ll abide by basic principles, such as guaranteeing lifetime tenancy and allowing you to transfer the scheme to a new property.
The best place to start is StepChange, a charity that offers free impartial advice on equity release. They also provide both lifetime mortgages and home reversion schemes with transparent fees. Their advisors don’t receive commission, so there’s no pressure to sell you a product. Take a look at their website for more information and to calculate how much you could potentially release from your property.
Equity release certainly isn’t right for everyone. You could end up with all the responsibilities of property ownership but lose many of the benefits. If you’re still working and haven’t yet reached retirement age, there’s still time to build up your retirement income. Read my post on Building Your Retirement Assets for guidance on how to get started. Another alternative is downsizing, which we’ll explore in a future post. Although equity release is a boon to some, it can be a curse to others. As ever, make sure you go into it with your eyes open.
This blog post is for information only and does not constitute financial advice.