Rising numbers of older homeowners are resorting to equity release to help out loved ones during the coronavirus crisis.
Despite the lockdown, equity release providers have handed out loans worth millions of pounds.
Recent figures show that the proportion of borrowers using the wealth in their home to help out relatives had risen 20 per cent, from 13.13 per cent to 15.95 per cent of all loans secured in April.
But experts have warned that the product can be dangerous if you don’t enter into it knowing all the risks.
If you’re considering equity release, this ten step guide can help you better understand what’s out there.
What is equity release?
Equity release allows those who are asset rich but cash poor to draw on their home’s value in their retirement – or in the approach to retiring – by taking a loan repayable after their death.
There is no need to make monthly payments with equity release, as there is with a mortgage, but this can lead to a downside as interest rolls up over the years.
That means that equity release leaves less for to your loved ones as an inheritance, so it may be worth looking at alternative ways to raise income.
It is possible to limit this with modern equity release loans by choosing to take funds gradually through a process known as drawdown (which limits interest being charged on a lump sum taken out in one go) and in some cases monthly interest payments can be made.
Before you entering into equity release it is essential to take professional financial advice. And if you are considering it, make sure you read our ten points to consider below.
About equity release
Equity release allows you to tap into your home to fund retirement, spend on home improvements, or pay care bills and stay in it at the same time.
The main type of equity release product is a lifetime mortgage, where you borrow against your home’s value and interest rolls up to leave a debt that is eventually paid on your death.
A less popular alternative is a home reversion plan, where you sell a chunk of your home for a cash lump sum.
If you are considering equity release make sure you ask about ways to make it cheaper, such as making interest payments, use a professional qualified adviser to help you through the process and compare the best rates and check how much you will pay in fees.
1. Could you downsize?
Consider all the alternatives first, such as moving to a smaller home. Capital raised this way will cost you less in moving expenses than in equity release set-up charges and interest.
2. Speak to your family
If you do not wish to move, it is essential to discuss your plans with your family before proceeding with equity release. This will avoid any unnecessary family surprises later on and they may be able to suggest alternatives.
3. Get professional advice
With many equity release schemes available it will be difficult to find the best deal yourself. Not only that, many of the schemes are available only through authorised intermediaries. So find an independent specialist in equity release advice.
4. Choose your adviser carefully
What are they charging, do they compare all the deals on the market? Also are they able to advise on pensions, entitlement to welfare benefits and long-term care funding? Some of this may be relevant to you now or in the future and the wrong advice could cost you dearly.
5. Find out about fees
Ask your adviser about equity release fees – and make sure you get value for money.
The impact of compound interest on an equity release plan is particularly important to be aware of.
The best friend of savers, the downfall of borrowers, the effect of compound interest is really what bumps up the cost of equity release.
Interest rates on equity-release plans are lower now than they once were but tend to be at least 4 to 5 per cent. In contrast, mortgage rates can be found at below 2 per cent.
Interest rolling up on equity release can be expensive.
Say you borrowed £50,000 at 5 per cent. In the first year, you would accrue £2,500 interest.
In the second year, you would then pay interest on the original £50,000 plus on the extra £2,500 that your debt had increased by (£52,250) – so total interest of £2,625. This is then added to your debt, too, bringing it to £55,125 at three years in.
This continues on and by ten years in you would owe £83,350.
One way to help keep costs lower is to pay off the interest as you go. Choosing to pay back just £100 a month can make a real difference – in the example above interest would then be accruing at just half the rate.
You should also find out what would happen if you find yourself unable to continue to live at home and needing to move into a care homes.
6. Only borrow what you need
Borrow only as much as you intend to spend or give away. You will earn much less from cash left on deposit than the interest you will have to pay for borrowing it in the first place. It could also cut your entitlement to means-tested benefits.
How much can you release?
Like mortgages, equity release loans are offered up to set loan-to-values – the size of the loan as a percentage of your property’s value.
However, equity release is offered only up to a far lower loan-to-value than a traditional mortgage. This is because interest is not paid off on the loan and instead rolls up, meaning the amount to be repaid increases over time.
Equity release providers should guarantee that you will never have to repay more than the value of your property.
You may alternatively wish to consider a drawdown plan that offers a cash reserve facility. Rather than just receiving a lump sum, you have the option to release your cash over time, as and when you need it. Because interest is only payable on the cash you have taken, these plans can often prove more cost effective.
7. Pay attention to the APR
When comparing lifetime mortgage interest rates always pay particular attention to the APR [annual percentage rate] which considers the total cost of borrowing over a year including any fees – and not just the headline rate. The difference can add up to 0.5 per cent on the rate actually charged.
This is due to the costs of setting up the arrangement and how interest itself is calculated.
This can be daily, monthly or annually. The longer the period the better it is for the borrower. (The exact opposite is true for traditional repayment loans.)
8. Do you understand the product?
Ask your adviser about continued support and advice. This could range from claiming welfare benefits, or care and support from the local authority, to mitigating inheritance tax. Advisers who specialise in elderly client advice will be in a better position to help than a traditional mortgage adviser, for example.
Make sure that you have understood the various features of equity release plans, and which are most important to you. If you’re planning to take out a lifetime mortgage, how do the set-up costs vary from one plan to the next?
Do you plan to move in a few years time or is there a chance that you may wish to repay some or all of the loan at some stage in the future? Do you want to guarantee that some of your equity is protected so that it is passed on in your estate?
A good adviser should be able to talk through all of a plan’s features in a way that you can understand.
9. Get legal support
You will need a solicitor. If you have one make sure to ask if they are familiar with equity release paperwork. Otherwise the process could take longer and cost you more in fees. There are now a significant number of solicitors who have undertaken additional training in this specialist area. Your equity release adviser should be able to introduce you to such a firm.
10. Know your goals
Make sure you have a clear idea on your key goals when embarking on this path. Your personal priorities and views on the direction of house prices will materially influence what is right for you. Your equity release adviser should be able to guide you. If not, seek alternative specialist advice.