Downsize vs equity release: what’s the right decision for you?
The baby boomers are the generation who have benefited most from home ownership and rising house prices, according to a recent Resolution Foundation report.
As a result, those in their 50s and 60s looking ahead to retirement are increasingly tapping into their property wealth to help support them in their later years.
Downsizing to a smaller home has been a traditional route to access capital, but figures from the Equity Release Council (ERC) reveal annual lending surpassed £2bn for the first time in 2016 and there has been a 225% increase in equity release product options in the 10 years to July.
Homeowners may be considering whether downsizing or equity release is better for them, so below, we set out some of the key considerations.
If you are selling your house to move into a smaller property, you will need to allocate money for the estate agent, removal van, valuation, stamp duty, legal fees and mortgage fees (if applicable).
These costs can set you back a tidy sum, from around £500 for an online estate agent to several thousand for a high street agent depending on the property value (average commission is 1.3% of the sale price). Removal costs can also typically add £1,000+ to the cost.
Stamp duty rates have shifted and can absorb a significant chunk of relocation costs in more expensive homes. Based on a £250k property, you would need to pay a £2,500 bill to HMRC.
If you’re considering downsizing but you still have a mortgage and would require a small mortgage for the new property, it may not be so simple. Nick Morrey, mortgage and protection consultant at John Charcol, says many lenders have a minimum income requirement, which could prove difficult for older borrowers. He says: “Many people in their 70s are still working so they’re earning an income but if they want a mortgage, the lender will look to see if they can afford the payments in later life. That income has to support their mortgage which can make it tricky for quite a few people.”
Morrey adds that for downsizing to be worthwhile, homeowners should have at least £150k to £200k equity and they need to be realistic about such a move. “Someone in London with a three or four bedroom detached house with a garden is probably looking at a £600k value, and if they have a £200k mortgage and can release £400k equity, this is feasible for a two bed house in London. However, a £180k house in Sheffield with a £125k mortgage outstanding means the homeowner can release £55k equity, so lenders will say they probably can’t downsize”.
Another point to note is that if you’re on the title deeds of any other property, there’s a chance you’ll need to pay the 3% stamp duty surcharge upfront, though you can claim a stamp duty refund.
Brian Brown, head of insight at Defaqto which rates equity release providers, also adds that while there is no capital gains tax to pay on the sale of a primary residence, any large capital sum could affect benefit entitlements. While he acknowledges someone with a half a million pound house may not be in receipt of benefits, it’s best to be aware of any impact this may have, particularly once a large sum is deposited into your bank account.
For equity release there are no moving costs, but the product typically includes set-up fees which can be high and homeowners will also need to take advice for this life-changing decision, which will also come with a cost. However, with equity release most of the costs are delayed until after you die or go into permanent social care. Morrey says: “Whatever you borrow will get bigger over time as the interest is rolled-up. When you die, the property is sold and the amount is repaid. With equity release, the interest is much higher. A residential two-five year mortgage is around 1.5% – 2.5% but with equity release, it’s likely to be 5%-7%.”
However, Nigel Waterson, chairman of the ERC, says average interest rates have fallen significantly in recent years, making equity release “even more attractive to consumers”.
“The average rate for August 2017 was 5.25%, compared to 5.93% in August 2016, and 6.20% in January 2016. Assuming interest is rolling up at August’s average rate of 5.25%, this means the size of the loan will double roughly every 14 years. However, many products now come with added flexibilities which allow for interest or capital payments to be made, either on an ad-hoc or monthly basis. This stops or reduces interest being rolled-up into the loan with no risk of the customer defaulting on their payments, as you can switch to roll-up arrangements at any point,” he says.
Your circumstances and well-being
While those in their 50s may be physically able to downsize, for older, less mobile people, it can be a more complicated matter. Brown says a good starting point is to ask why you want to release equity, and how much you need.
He says: “If an older person is starting to have accidents and the bathroom or bedroom are on different floors, they may need £10-£15k to convert a room. Do they really want to sell a house they may have had since the 1950s? Instead they could borrow on equity release and have the house for the next 10-15 years and be comfortable in their own home. Equity release is for those who want a small amount of money in later life for repairs and maintenance of their homes.”
He adds that another group of people where equity release can help are those approaching retirement or who are already retired but may still have an interest-only mortgage. He says: “The mortgage comes to a natural end but the homeowner can’t afford to repay the interest as their income’s reduced. They may not have paid off any capital from the mortgage but they’ve built up equity, so equity release allows them to stay in the same house.”
Waterson adds: “Many people have a strong emotional connection to their homes, while others may want to remain close to family members or part of a community, and simply cannot find the right properties to downsize into within their locality. There is also no guarantee that downsizing will free up capital, depending where they move to. For these people, equity release can form part of the solution that allows them to remain in their home while also generating additional income in retirement.”
Inheritance tax and pension planning
While some may want to stay in a house where all your memories are intact or you want a big enough house to have the kids or grandkids stay, for others, it’s about passing on the full value of your property to your children, says Morrey.
“If you go down the equity release route, whatever you borrow will get bigger and bigger as interest is rolled-up. Whatever equity is left after the amount has been repaid can be passed down to your family but it will be significantly less than when you take out the equity release product. If you sell your house and downsize, you can gift your money to family without inheritance tax as long as you live for another seven years. It’s essential for people to get tax advice regarding this.”
Brown says equity release is a decision that you should let your family know about so there are no surprises later on as it will impact your inheritance plans.
“A small number of people will have valuable homes with a large amount of cash so they can leave their pension untouched and drawdown equity on the house if they have a large enough pension pot. Rather than taking money out of your pension (which is not part of your estate for death tax purposes), you can take money out of your house, leaving the money in your pension pot to grow,” he says.
For more information, see YourMoney.com’s Equity release: 10 points to consider before taking the leap