Equity release: 10 points to consider before taking the leap
Figures from the Equity Release Council (ERC) show the total value of equity release lending grew by 77% between 2015 and 2016, and according to Key Retirement over 17,500 new loans were taken out in the first half of 2017, with an average amount borrowed of £70,000.
Although equity release can be a game-changer, people need to consider both the benefits and the potential issues that equity release can bring.
There are two types of equity release; home reversion and lifetime mortgages:
Home Reversion: these plans allow you to sell all or part of your home to a reversion provider in return for a cash lump sum or regular payments. They are not a popular product and not a first choice for consumers looking at equity release.
Lifetime Mortgages: these allow you to take out a mortgage secured on your home, but you always own it. When you die, or go permanently into a care home, your house is sold and the debt repaid. Almost all equity release products sold these days are lifetime mortgages (there are 170 propositions from 11 providers), though they tend to be more expensive than an ordinary mortgage.
You can only get an Equity Release product through an advisor, who will help you choose the right product and explain the terms and conditions before you sign up, but even with advice there are a number of things potential borrowers need to consider:
1) No negative equity guarantee
This means if there isn’t enough money left when the property has been sold, then there is a guarantee that you do not have to pay any outstanding amount on the lifetime mortgage. In essence, you can’t go into debt beyond the value of your home. This is part of the ERC standard.
2) Set up costs
Advice and administration costs will usually apply and consumers need to know what they are.
3) Age limit
The minimum age for taking out one of these loans is 55. Research from Defaqto shows 40% of the products on offer are available to applicants with a minimum age of 55 with the remaining 60% being available to those aged 60 and over.
4) Amount you can borrow
The amount of equity you can take out of your home will depend on your age, medical condition and the market value of your property. The loan-to-value (LTV) ratio can vary from a minimum of 9% to as much as 55%. Of the 170 products, 108 have a minimum loan of £10,000 and some providers offer maximum loans of £2 million or more.
5) Interest rates
With a lifetime mortgage it is important to understand that the interest on your loan is being rolled-up so over time it can roll-up well beyond the value of the original lump sum taken out. Interest rates for equity release products can vary between 3.69% and 7.15% APR with an average of 5.99 %. Of the 170 products, 89% have fixed interest rates, almost 9% are variable and just over 2% have an initial discounted rate before becoming fixed.
6) Interest payments
With 30 of the 170 products, you have to pay either 100% of the interest or you can choose between 50% to 100% or a minimum monthly payment of £25. This arrangement can vary for a fixed period or for the term of the mortgage. Another 12 allow unlimited voluntary contributions from £50. This will have a big impact on the debt because if you are servicing the interest each month, the debt will remain the same (as in an interest-only mortgage). Even if you pay a proportion it will negate the effects of interest roll-up.
7) Rights to remain in the property for life
You have the right to remain in the property for life or until you need to move into a care home. If you need to go into a care home, then currently the £23,250 asset limit for state help for care home residents applies. It is therefore important that there are legitimate reasons for taking out equity. This needs to be documented to show that you have not deliberately deprived yourself of assets, thereby relying on the council to pay your care home fees. This would not be looked upon favourably by any local authority when it comes to assessing your care package entitlements.
8) Right to move
All lifetime mortgage release products designed under the ERC standard are portable, provided you meet the terms and conditions of your providers contract, for example you may well be asked to reduce the level of your debt before moving to a lower value property. Portability might also depend on the type of property you intend to move to.
9) Drawdown or lump sums
You will need to decide if you want to release money in several payments or in one lump sum.
10) Early repayment charges
If you decide later on that you want to sell your house and pay off the lifetime mortgage, lenders will charge an early redemption penalty. There are two types of penalty; fixed (where you can calculate at the outset how much this would be), and variable (where the amount of penalty will be calculated based on investment returns at the time. Over half 55% of the products are fixed and 45% are variable. The advantage of fixed early repayment charges mean that from the outset you know what you will be charged if you repay the loan early, with variable ones you only know the maximum you may have to pay.
Brian Brown is head of insight at Defaqto