By Tom Philips at October 4, 2022

Equity Release Plans Without Rolled-Up (Compound) Interest

There are two types of equity release: lifetime mortgages and home reversions. Both schemes involve accessing funds from your home in the form of a loan that does not have a deadline for repayment.

To qualify for equity release, you have to own a home worth at least £70,000, you must be at least 55 years old, and it is preferable if you do not have an existing mortgage.

People who are cash poor but have valuable properties may benefit the most from this scheme, but you are free to take out equity regardless of your income.

Interest is always applied on equity loans, so this is not something you can avoid as an equity release applicant. However, you can look for the lowest interest rates on the market, as well as finding equity release plans that do not involve compound interest.

Before you dive into equity release plans without rolled-up (compound) interest, have a look at our article on how equity release works to get a better understanding of the scheme.

What are the Different Equity Release Plans in the UK?

We have stated that there are two forms of equity release: home reversions and lifetime mortgages. We want to introduce you to both of these in detail so that you can understand their relationship to interest later down the line.

Home reversions are less popular than lifetime mortgages, but nevertheless, they can provide a great opportunity for pensioners to access the funds that are tied up in their home without having to worry about repayments.

If you have a home reversion, you will no longer be the homeowner of your property. The equity release provider who has bought a share of your home will be entitled to your property. However, you will still be able to live there for the rest of your life.

When the home reversion comes to an end, which occurs when you die or go into permanent care, your family will have to move your possessions out of your home in order for the equity release provider to sell it onto someone else and take enough of the proceeds to cover your debt.

Lifetime mortgages only becoming more popular as the cost of living is increasing. Much like a traditional mortgage, homeowners take out a loan for a lifetime mortgage, but the difference is that this one does not need to be repaid and therefore a homeowner can spend the money on whatever they want.

There is much more variety when it comes to lifetime mortgages as there are eight different types: voluntary repayment plans, income plans, interest-only plans, buy-to-let plans, enhanced plans, drawdown plans, second home plans, and lump sum plans.

This means that the general experience of taking out a lifetime mortgage is completely different depending on which type you choose.

You may receive your money in a lump sum or in regular instalments, the interest rates will vary, and the repayment rules will vary.

Many of our clients ask us whether taxes applied to equity release funds, and the answer is no. All money received through your equity release plan is tax-free, which includes both income tax and capital gains tax. This is the same for home reversions and lifetime mortgages.

What is Rolled-Up Interest?

The equity release scheme relies on rolled-up interest. This means that interest is charged not only on the initial borrowed amount of money, but also on the interest that is charged each year (1).

In the first year, the interest will be at its lowest, as it will only be charged on the initial loan amount. However, as the years go by, you will be paying more and more interest as it will accumulate based on how much interest you have paid each year. In other words, the interest is compounded.

This does unfortunately mean that younger homeowners will end up owing a larger amount of interest by the end of the scheme.

You may want to avoid taking out equity at a younger age for this reason, if you are fortunate enough to be able to have a pension and/or savings to rely on.

However, please remember that there is no deadline for repaying the interest. This means that you may find it more beneficial to release equity and owe interest if it means that you can enjoy your retirement in the meantime.

This is especially true if you do not have any beneficiaries that you want to pass your money on to when you die.

Please also remember that it is likely that your property value will increase over the years. This means that the amount of interest you are charged will be slightly lower as it is calculated based on how much your property is appreciating or depreciating in value.

How Much Interest is Charged On Equity Release Loans?

As of January 2022, interest rates on lifetime mortgages are lower than ever before, at an average of 4.16% (2). The interest rate on equity release tends to be lower than it is on traditional schemes.

However, the interest rates can vary quite a bit depending on which equity release plan you take out and which equity release lender you are working with. What’s more, if your interest rate is variable, it will change over the duration of your equity release scheme.

You can access lower interest rates with certain lenders for various reasons. Generally, the older you are, the lower your interest rate will be on your equity release loan.

The more valuable your property, the more likely it is that the lender will offer low-interest rates. Finally, if you have a particularly good credit rating, you may be able to benefit from low interest with equity release (3).

Why is Interest Charged On Equity Release Loans?

The answer to why interest is charged on equity release loans is simple. You are benefiting from a loan that does not need to be repaid while you are still alive, so the lender needs to know that it will be worth it to offer a loan to you.

If they know that you will have to pay back a large amount of interest that accumulates over the years, they can trust that their decision to provide you with a secured loan will be fruitful for them.

Which Equity Release Schemes Involve Compound Interest?

All equity release lifetime mortgages involve interest. It is sometimes possible to tackle the interest early by repaying it, but we will explain how to do this in more detail later on.

In short, there is no way to avoid the interest involved in equity release unless you have a home reversion instead of a lifetime mortgage. All you can do is choose low-interest plans, preferably ones that offer a fixed interest rate, otherwise, it could rise to an unexpectedly high level.

Yet, if you want to avoid compound interest, you can do this by opting for voluntary repayment schemes. This will allow you to keep on top of the interest on a regular basis, so that it never accumulates to a value that you are not happy with.

This way, you would still be paying the interest, but you wouldn’t have to be charged compound interest on your loan on an annual basis.

Equity Release Plans With High-Interest Rates

The enhanced lifetime mortgage tends to come with high-interest rates if you do not meet the eligibility criteria for the benefits that come with the scheme.

However, if you do qualify (which usually involves reaching a minimum age requirement or having a disability), one of the bonuses is that you can pay less interest, so it is not as simple as to say that this type of equity release always involves high interest.

Another equity release plan that is usually associated with high-interest rates is the drawdown lifetime mortgage. This may be in part because it is a variable interest rate that increases after you take out your initial lump sum, so you may end up paying a lot of interest back on your withdrawals.

However, with a drawdown lifetime mortgage, you only pay interest on the cash that you withdraw. This means that the amount of interest you are paying will vary depending on how much money you are taking out of your cash reserve.

Some people keep their equity funds in their cash reserve as savings unless they absolutely need to dip into the money. For these people, the interest that they pay may be on the lower side, as they are only paying interest on the rare occasion that they take out the money.

Equity Release Plans With Low-Interest Rates

To find an equity release plan with low-interest rates, it is always best to have a look at the most common schemes. The best example we can think of is the lump sum lifetime mortgage.

As a result of this scheme being very popular in the UK, the interest rates are competitive and fixed for life. Many people prefer equity release plans with fixed interest rates as they know what to expect in terms of how the interest is going to accrue.

However, it would be unwise to rule out equity release arrangements with variable interest rates, given that there are some great deals on the market for variable interest rates.

Are there any Equity Release Plans that are Interest-Free?

The only equity release scheme that is completely free of interest is the home reversion. Once you receive your lump sum of tax-free cash, the money is all yours, and you do not have to worry about interest at all.

However, not everybody is keen to have a home reversion as will not be offered the market value of your home by the equity release lender, so you have to sell a share of it for less than it is worth.

What’s more, if the value of your home appreciates over the course of the equity release scheme, which is very likely, the share that you have sold to the equity release provider will be much more fruitful for them, but not for you.

How to Control Compound Interest On an Equity Release Scheme

If the idea of owing compound interest on an equity release loan makes you nervous, there are ways that you can keep the interest low.

1. Have a home reversion

We have already stated that home reversions do not involve interest payments, so perhaps the best way to avoid interest completely is to have a home reversion instead of a lifetime mortgage.

If you do this, the money is still tax-free, so you can take advantage of this by using it to fund large projects, or keeping it as a reliable monthly income for the rest of your life.

However, please remember that you would have to sell your property to an equity release provider and give up your status as homeowner. This means that you would no longer benefit from a rise in value of the share that you have sold to the equity release provider.

On the other hand, with a lifetime mortgage, you would continue to benefit from the appreciation of your property value, as it would free up more money for your loved ones in your property sale after you pass away.

2. Take out a drawdown lifetime mortgage

With a drawdown lifetime mortgage, after you have taken out a lump sum, you can dip into the cash reserve whenever you need additional funds.

This prevents the interest from accruing overtime as you are only taking out the money that you need, rather than paying interest on the entire loan as you would with a lump sum lifetime mortgage.

Drawdown arrangements are ideal for people who need a lump sum of cash, but would also benefit from receiving a boost to their retirement income each month.

For example, you may need access to tax-free cash for home improvements, but beyond this, you may need help when it comes to paying your bills each month.

3. Take out an interest-only lifetime mortgage

One great option for taking control of your compound interest is to request an interest only lifetime mortgage with an equity release lender near you. This would allow you to repay small amounts of interest each month, or even all of the interest if this is something you could afford.

This does of course require you to pay the same interest as everybody else to begin with, but it means the compound interest will be lower as you will have already repaid the interest each year so it will not be compounded.

Unfortunately, this lifetime mortgage is not a possibility for people who do not have another source of income to fund their lifestyle. This is because need to be able to repay the interest each month without delay.

Having said that, some equity release lenders are willing to come to an agreement that allows you to repay the interest on an ad-hoc basis or simply on a less regular basis than each month.

4. Take out a voluntary repayment lifetime mortgage

Finally, rather than repaying the interest on the loan, you could take out a voluntary repayment lifetime mortgage and pay back some of the loan whenever you can afford it. This does tend to be on an ad hoc basis, but you may be able to put a regular payment in place.

This means that when your interest is calculated at the end of each year, there will be less interest charged on your loan amount as the borrowed amount of money will have decreased, which can make a big difference when it comes to how much you owe by the end of the scheme.

Something tonight when it comes to this type of equity release plan is that there are some limits in place. For example, you may not be able to simply repay a large sum of money at once, as there may be restrictions on the repayment amounts.

You may also have to wait until a certain date before beginning to repay, and you may not ever be able to repay the loan in full, depending on the lending criteria put forward by your provider.

How is Equity Release Interest Repaid If You Do Not Have a Repayment Plan?

You may be wondering how homeowners repay the interest on their equity loan if they have not selected a repayment plan, such as an interest-only lifetime mortgage or a voluntary repayment lifetime mortgage.

The answer is that the equity release lender collects the money from the property sale after the homeowner has died or gone into permanent care. They will take enough money to cover the loan amount as well as any interest that has accrued over the years.

It goes without saying that this does not affect the homeowner’s retirement, as it all happens after they have passed away.

However, it could affect their family’s inheritance. This is why some plans offer inheritance protection to ensure the equity release consumers’ family still inherits some of their funds.

To find out more about how taking out a lifetime mortgage could impact your family, due to compound interest amongst other things, get in touch with us and we will explain the impact of equity release on inheritance in more detail.

Aside from the general disadvantage of having less money to pass on to your beneficiaries, where is the advantage of not having to pay inheritance tax on your funds, so this is certainly something to weigh up rather than immediately dismissing equity release as a scheme that is unhelpful for your family members.

What Happens If My Property Decreases in Value and I Cannot Afford to Repay the Interest?

In the past, it has been the case that some properties of equity release consumers have decreased in value overtime, meaning that the value of the property ended up lower at the point of sale than it was when the equity release lender first offered a loan to the homeowner.

When this occurred, the equity release lender would demand more money from the homeowner, as they would not have enough money to cover the cost of the initial amount of money borrowed.

Of course, the homeowner would either have passed away, or be living in a care facility. This meant that the family of the homeowner would have to find a way to collect enough money to pay back the equity release lender.

This may be part of the reason that equity release still has a reputation for being unsafe. People are concerned about putting their families in a financially vulnerable position when they are no longer around to help out themselves.

However, we are happy to say that this no longer has to be the case with equity release. Many equity release plans now include a no-negative equity guarantee.

This means that no matter how much the homeowner’s property depreciates in value, they will only ever to pay back the amount that they borrowed at the beginning of the scheme, as well as any interest that has accrued.

Families of equity release consumers canal relax in the knowledge that they will never have to find the funds to pay back the equity release lender. Instead, the lender sells the homeowner’s property and takes a chunk of proceeds from this, leaving the rest to their loved ones.

We would always recommend that you find a lender that is willing to offer you an no negative equity guarantee, as well as a plan that accommodates this. We can help you to do this if you get in touch with us.

The great news is that all equity release lenders who are affiliated with the Equity Release Council are obligated to offer no negative equity guarantee (4).

This means that all you need to do is ensure that your provider is a member of the ERC, and the rest will be done for you.

We already recommend that all of our clients find equity release providers that are approved by the ERC. This is because they ‘promote high standards of conduct and practise’ in the equity release industry (5).

Though the equity release scheme has not always been safe, with companies like ERC advocating for highly-regulated lenders and plans, that could never be a safer time to take out equity from your property.

Will Your Equity Release Calculator Tell Me How Much Interest I Will Have to Pay?

Our free equity release calculator serves to tell you how much money you could release from your property, according to the value of your home, the type of home you own, and your current age.

Unfortunately, if you are looking to find out how much interest you will have to pay on your loan, the equity release calculator is not the place to go.

Instead, you should speak to an equity release adviser to find out what the interest rate is on your chosen plan with your chosen lender.

You should always be aware of the proposed interest rates when you are making an equity release application to a lender. Otherwise, you may eventually find out that the interest rate is too high for your liking, and you would have to waste an application.

Equity release applications take time and cost money, so it is better to do your research into interest rates before you reach out to an equity release lender near you.

Get in Touch to Discover How You Could Release Funds From Your Property

The only way that you can accurate estimate of how much money you could release from your property is by contacting us for a free consultation. We are ready to discuss what equity releases, how it works, and the relationship between equity release and interest.

If you want to avoid paying high-interest rates, we can recommend plans that have notoriously low rates, such as the lump sum lifetime mortgage.

We will also talk you through the concept of a repayment plan so that you can decide whether this is something you can afford and something you would be willing to get involved with.

We can also explain what the interest rates are usually like with equity release. This of course depends on which lender you choose and which plan you go ahead with. Generally, the interest rates on equity release are lower than they are on other schemes.

However, this is in part because equity release relies on compound interest. We will be able to calculate how much interest you would be paying on your loan so that you can decide whether it is worth it to owe this much interest without having to pay it back, or whether you would rather take out a traditional loan that must be repaid, but that does not rely on compound interest.

Interest rates are not the only thing to consider when you are deciding whether to take out equity from your property.

You should always research your preferred equity release plan in great detail, focusing on everything it provides, not only the interest rate that would be charged.

The reason this is so important is that you may end up saving money by paying high-interest rates if your equity release plan offers other benefits instead. For example, with the enhanced lifetime mortgage, the average equity release consumer tends to pay high-interest rates.

However, certain homeowners are eligible for benefits when it comes to this plan, and part of this is the offer of low-interest rates. This may be provided to people who are above a certain age, as well as people with certain disabilities.

You will usually have to offer your medical records to the equity release lender so that they can check your eligibility.

A health questionnaire is also provided, to determine whether do you have a disability that would make you eligible for an enhanced lifetime mortgage.

Some examples of people who may qualify are: anyone who is taking prescription medication, anyone with a BMI that is outside of the healthy range, anyone who has retired early as a result of poor health, anyone with a chronic illness such as diabetes or high blood pressure, and anyone who smokes.

You will be asked further questions to determine how your condition affects your life. For example, you may not qualify simply because you are a smoker, unless you are smoking a certain amount of cigarettes a day and it is clearly impacting on your health.

To find out more about how you can access low-interest rates with an enhanced lifetime mortgage or any other equity release product, call us on 0330 058 1579 for a free consultation with a member of our team of equity release specialists.

We will never pressure you to make an application to an equity release lender. We promise to give you time to think about your decision, which will hopefully include researching alternatives to equity release.

However, if you have already done your research and you are determined that this is the right decision for you, we will be able to guide you on how you can make an equity release application in order to receive an equity loan within the next couple of months.

We know that the application process may bring about more questions for you, so we will prepare you for it by explaining how each stage of the process works, how long it takes, and how much it costs.

We will also advise you to find a solicitor to help you with the legal aspects of equity release. This is a requirement of equity release, as it puts you on a level playing field with the equity release lender, who will have their own solicitor. It will also help you to release equity in a safe way.

References

[1] What does rolled-up/compound interest mean? https://www.equityreleasecouncil.com/what-is-equity-release/faq/what-does-rolled-up-compound-interest-mean/

[2] Are You Looking to Find The Lowest Interest Rate on Equity Release?

[3] What interest rate can I achieve on my equity release?

[4] What is a no negative equity guarantee? https://www.equityreleasecouncil.com/what-is-equity-release/faq/what-is-a-no-negative-equity-guarantee/#:~:text=Products%20which%20fully%20meet%20the,worth%20when%20it%20is%20sold.

[5] About the Equity Release Council https://www.equityreleasecouncil.com/about/#who-we-are