Equity means different things to different people. In general parlance, it simply means fairness. In showbiz, Equity is the name of the actors' union. In law, equity describes a set of principles and maxims used to mitigate the strict interpretation and application of the common law.
But in conveyancing, equity may also simply represent the difference between the value of your mortgage and the value of your property . Where the value of your mortgage is higher than the value of your property, you're in what's known as negative equity -- for people in this position, equity release simply isn't an option. However, if the value of your property significantly outweighs the value of your mortgage, or you've already paid off your mortgage, equity release is definitely worth considering.
What is equity release?
Essentially, equity release allows you to unlock the value of your property , without having to move home. It can provide a lump sum or a regular income , or both. The release of money can be used in any number of ways and to decrease the value of your estate for inheritance tax purposes.
Who should consider equity release?
Equity release is for people over 55 or 65 (depending on the type of equity release scheme you apply for), who own property in relatively good condition, and have either paid off their mortgage or a substantial part of it -- it should not be confused with equity withdrawal, which is when people withdraw additional money from their homes by remortgaging.
Is there more than one type of equity release?
Yes, there are two broad categories of equity release:
- Lifetime mortgages allow people to borrow against the value of their property.
- Home reversion plans require the sale of all or part of the property to realise a lump sum or income, but the borrower retains the right to live in the property rent-free until death.
What happens if I die or want to move?
If you live in the property until you die, the money from its sale is used to pay the lender -- any equity left over is then paid to your beneficiaries.
What happens when you sell the property before you die depends on the equity release scheme: for lifetime mortgages, you must repay the money you borrowed; but for home reversion plans, provided you still own a part interest in the property, you are entitled to receive a proportionate share of the sale proceeds.
Tell me more about lifetime mortgages.
There are two main types of lifetime mortgage:
1. Interest-only mortgages
Here, borrowers receive a lump sum secured against the value of their property. They pay monthly interest on the loan and can pay it off if ever they decide to sell the property.
The interest rate may be fixed or variable. But if it is variable, and the borrower's pension or other source of income is fixed, they will find it more difficult to meet their repayments if interest rates rise.
To avoid this problem, most borrowers invest the money they borrow, often in an income annuity. They use the income to pay the interest on the loan, and what is left over is theirs to spend. But because annuity rates are low and depend on your age, this type of loan is really only suitable for very elderly property owners.
2. Rolled-up interest loans
With this loan, a lender provides a lump sum or a monthly income (or both), based on the value of a borrower's home. Nothing is repaid until the borrower dies or the property is sold, but annual interest is added to the amount borrowed. This is 'rolled up' over the life of the loan.
The value of a borrower's home and their age will determine how much they can borrow. The older they are, the greater the percentage of their home's value they can borrow.
As above, the interest rate on the loan may be fixed or variable. If it is variable, it could also be capped, which means it cannot go above a certain level.
Sometimes property loses value during the loan period. Most lenders offer a 'no negative equity' guarantee to cover this situation. This means that the amount a borrower pays back to the lender will never be more than the value of their home.
Now tell me more about home reversion plans.
With a home reversion plan, a property owner agrees to sell all or part of their property for an agreed amount; they then receive the money as a lump sum, as income, or both.
The money paid under a home reversion plan, however, never reflects the full market value of the property. This is because whoever buys it will not get their money back until the vendor dies or moves out -- so they might not get a return on their investment for a very long time.
How much does equity release cost?
The cost depends on the type of plan you choose, its terms and the amount of equity you want to release. Lenders should always provide a detailed breakdown of costs.
Here are the main costs you're likely to incur:
1. Administrative costs
The administration costs are usually between £300-600 and cover completion and application fees. Sometimes these fees are refunded by the lender / reversion company. Borrowers should ask about this and also about any future costs they would have to pay if they wanted to increase the size of their loan.
2. Legal fees
Again, these should be somewhere between £300-600. Borrowers should ask their solicitor for a fees breakdown.
As part of most equity release schemes, borrowers must take out builders insurance to cover the period that the scheme is in place. This will usually cost between £200-300 a year.
4. Property valuation
For a lifetime mortgage and a home reversion plan, borrowers must get their properties valued. The valuation fees depend on how much a borrower's home is worth, with higher charges for more expensive properties, but you can generally expect to pay around £100-300. As with administrative costs, some companies refund these fees.
5. Early repayment penalties
If a borrower pays a lifetime mortgage early, they will probably have to pay an early repayment charge.
6. Arrangement fee
All lenders and mortgage intermediaries who lend, advise on, or arrange lifetime mortgages must be authorised by the FSA. If a borrower is using the services of a mortgage intermediary who charges a fee, the charge must be clearly explained to them. Not all mortgage intermediaries charge a fee but those who do usually charge between 0.5% and 1.5% of the amount a person borrows.
I like the idea of extra income or receiving a lump sum from equity release, but what else do I need to bear in mind?
While equity release is a good way to decrease your inheritance tax liability, it may also reduce the amount of money your loved ones inherit on your death. Your family may also lose the property, which may be important for some people. Therefore, it's probably a good idea to discuss equity release with close family members before making a decision to go ahead, as this may help avoid any unpleasantness or misunderstandings.
In addition, you may lose your right to means-tested benefits if you pursue equity release -- which means that you may have to pay more for things like dental treatment and glasses.
You should also consider whether you have other assets or investments which could boost your income or give you the lump sum you're looking for. Maybe even your children or other relatives could help out (particularly since they could stand to inherit the property). Consider, too, whether moving to a smaller, less expensive property might be a better way of releasing money tied up in your home than pursuing equity release -- remember companies that offer equity release not out of pure kindness, they're looking to make a profit!
Also, to minimise risk, consider investing only in schemes carrying the SHIP logo. SHIP stands for Safe Home Income Plans . The group was set up in 1991 to protect consumers investing or thinking about investing in equity release. Companies who are members of SHIP have to provide a number of guarantees and abide by a strict code of practice.
Summary of pros and cons of equity release
- A lump sum may allow you to pay off debts, pay for a holiday or for home improvements.
- Extra income may simply allow you to live more comfortably, rather than constantly worrying about making ends meet.
- Extra money could also mean you finally get to fulfill life-long ambitions.
- You could use a lump sum to help loved ones pay for a deposit on a house.
- Equity release can also be used to pay for care bills without having to sell up.
- Equity may have certain tax advantages.
- Equity release may mean your loved ones inherit less.
- It could lead to your family home being sold. This may be a particular issue if the property has been held in the family for generations.
- Equity release may affect your current or future means-tested benefits.
Where you I go for help and advice about equity release?
Always seek advice from a solicitor and an independent financial planner before investing in an equity release scheme.
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