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Equity release 101 – how does it work?

If you have equity built up in your home, it’s possible for you to release this cash as a lump sum, while continuing to live in your property.

This is known as ‘equity release’.

However, while equity release can raise cash quickly, it’s not always the most cost-effective option and requires a great deal of thought and consideration.

How does equity release work?

Equity release policies are only available to you if you’re aged over 55.

You don’t have to have paid off your mortgage to take on an equity release policy, however.

Cash through equity release can usually either be taken in one lump sum, via a batch of smaller payments or a mixture of both.

Types of equity release policy

There are two main types of equity release policy:

1 A lifetime mortgage

If you’re aged over 55, a lifetime mortgage sees you borrow a sum of money against your property’s value, usually at a fixed interest rate.

However, the difference between a lifetime mortgage and a standard home buying mortgage is you often won’t pay off any interest or make any repayments.

So, the interest grows over the life of the mortgage until such time as it’s paid off upon death, usually through the sale of the property.

‘Drawdown’ lifetime mortgages do allow some of the interest to be paid off, so the cost of the mortgage is reduced.

2 Home reversion plans

You may have seen adverts for these equity release products on television.

Home reversion plans are only available to those aged 65 or over.

This type of policy sees the provider pay you a tax-free sum to buy a percentage of your property at a lower-than-market-rate valuation.

You then continue to live in the property until death, at which time the home is sold and the sale money is split between the percentage you owned and the provider’s percentage.

Of course, if your home grows in value after you take out the policy, the provider will receive more money upon the sale because their percentage will be worth more.

For instance, if you sell 50% of your property, which is worth £400,000, for a £120,000 lump sum, that’s far lower than the £200,000 that 50% share is actually worth.

If your property is later sold for £500,000, the equity release provider would receive £250,000 for their 50% share – a big increase on the price they originally paid.

How much do equity release plans cost?

The costs involved with equity release is what requires a great deal of thought before you sign up.

Interest rates for lifetime mortgages vary, but many are between 3% and 5% – substantially more than standard property purchase mortgage rates.

If you opt for a lifetime mortgage with no repayments, the interest grows over time.

This means the recipients of your estate will need to pay off the mortgage and interest, usually through selling the property.

For example, if you released £50,000 of equity at the age of 60, through a lifetime mortgage with an interest rate of 5%, if you live until the age of 74, that debt will have become around £100,000.

If you live until 88, the debt will be around £200,000.

On top of the interest associated with lifetime mortgages, you’ll also have to pay a mortgage arrangement fee, which could cost anywhere between £1,000 and £3,000.

Is equity release a good idea?

Whether equity release is a good idea or not really comes down to your personal circumstances.

If you’re looking to enjoy a more comfortable retirement by releasing cash from your home and you’re comfortable that the amount you leave as inheritance will be affected, equity release could be right for you.

Things you’ll need to consider include:

  • Your age
  • Your income
  • The amount you want to release
  • What your plans for the future are

You’ll also need to think about:

  • The interest rate of your lifetime mortgage lasts until your death, so if you live for many, many years, the debt will grow and this can affect the amount of inheritance you leave for loved ones
  • Home reversion plans will, most of the time, not give you a sum that is close to the true market value of your property
  • If you release equity from your home and then decide to downsize later in life, you may not have enough equity left to do this

Will equity release affect my pension?

Private and state pension entitlements are unaffected by equity release.

However, Guarantee Credit, which tops up the basic state pension, can be affected, so you should always request more information on this when deciding whether equity release is right for you.

Is equity release tax free?

There are no tax implications when taking out an equity release policy.

However, you will pay interest on the amount you release, so you’ll need to consider the impact of this when deciding if equity release is right for you.

Can you remortgage to release equity?

Releasing equity in your home by remortgaging is not the same as doing so via a lifetime mortgage or a home reversion plan.

If you’re under 55 and have built up substantial equity in your home through paying down your mortgage and your property’s value rising, you could consider remortgaging to release some of that cash.

If your home has risen in value and you’ve repaid a substantial portion of your mortgage, your loan to value (LTV) will have dropped.

For example, if you purchased your home for £200,000 using a mortgage of £150,000, that would be an LTV of 75%.

If your home grows in value to £250,000 and your outstanding mortgage is £130,000, that would be an LTV of 52%.

So, by remortgaging, you could potentially release £62,500 and keep your LTV at 75%.

Whether you can remortgage, and how much you can borrow, will depend on your lender’s affordability criteria and your age.

The closer you are to retirement, the more difficult it is to remortgage.

Your home may be repossessed if you do not keep up repayments on your mortgage or loans secured on it.

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