Why Equity Release Is Often Described as a Last Resort
Equity release is often a very attractive option for anyone over the age of 55, who owns a valuable property worth over £70,000 and who needs access to cash without moving home.
By opting for equity release, you can potentially unlock some of the money that is tied up in your home whilst continuing to live there until you pass away or move into a care home.
For homeowners who have a substantial amount of equity built up in their home, but limited retirement income, this can appear to be an attractive option.
Yet there is a reason equity release is often described as a last resort. The issue is not that equity release is necessarily a bad option.
In fact, for some homeowners, it can be a sensible way of accessing money in later life.
For a lot of people, the concern is that it can have a long-term impact on your finances which are often difficult to reverse.
The biggest consideration when it comes to opting for equity release is usually compound interest. When it comes to a lifetime mortgage, interest is rolled up and will compound rather than being paid each month.
This means that the amount of money that you owe will grow substantially year on year.
You might start with a relatively modest equity release loan, but as the interest is then charged on the outstanding balance, your overall loan amount increases significantly. This can gradually consume a significant proportion of the equity in your property.
Likewise, there are other concerns, too. For example, equity release can involve a number of different setup costs, might impact your ability to move home, can reduce the inheritance you leave behind and might come with early repayment charges.
This is why it is worth considering alternatives before committing to an equity release loan.
Compound interest
The most important reason to think carefully about equity release is the fact that you will be charged compound interest.
For example, if you release £50,000 from your property through a lifetime mortgage, the balance will increase year after year.
Eventually, you are not simply paying interest on the original £50,000. Instead, you are paying interest on the original borrowing plus the interest that has accumulated over the years [1].
This is how compound interest works. The longer the loan remains outstanding, the more compound interest you will be charged.
This is why age matters. Someone taking out an equity release loan at 75 might have a considerably shorter period for interest to accumulate than someone taking it at just 55 years old.
The longer you live, the more compound interest you will be charged. This does not mean older borrowers automatically get a better deal. Instead, it simply demonstrates why the length of time the loan remains so important.
Reducing your inheritance
The second major reason equity release is sometimes viewed as a last resort is inheritance.
Like with a lot of people, your home may be your largest asset. If you release some of its value through an equity release loan, then there is naturally less equity remaining in the property to go to your loved ones as inheritance.
With a lifetime mortgage, the outstanding loan and compound interest are only ever repaid when the property is sold once you pass away or move into long-term care.
If there is anything left over, then this will go to your loved ones as inheritance. If the proceeds from the sale of your home does not cover the loan amount, then the lender will cover the difference under the no negative equity guarantee.
If passing on your home or as much of its value as possible is important to you, then equity release might not be the best option for you.
The upfront costs
Equity release is not free, and it does involve a number of set up costs. These might include financial adviser fees, legal fees, valuation fees and other administration costs.
It is estimated that the cost of releasing equity from your home can vary between £1,500 and £3,000, depending on your specific circumstances and the equity release product that you opt for.
Often, equity release adviser fees alone can cost up to £1,500, with legal costs sitting at around £500 or more. Some providers or equity release advisers have been known to offer different fee structures.
However, these costs do regularly add up. If they are added to the mortgage, then you will ultimately pay interest on those costs as well [2].
Could you avoid equity release by downsizing?
Yes, for many homeowners, downsizing is the obvious alternative to equity release.
Rather than borrowing against your existing home, downsizing allows you to sell it and buy a cheaper property, therefore banking the difference.
The difference between the two values can then provide you with a lump sum of money, without having to take out a lifetime mortgage or pay interest.
For example, if your home is worth £500,000 and you decide that you could comfortably live in a property costing £350,000, then you will have access to £150,000 once you sell up your own home and buy your new property.
With downsizing, there is no compound interest or stress of taking out an equity release home.
However, many people aged 55 or over simply do not want to move home, as they have created many memories in their home over the years, are living close to loved ones and simply do not want the stress and pressure of having to move home.
Retirement Interest Only mortgages
A Retirement Interest Only (RIO) mortgage can sometimes be another alternative option.
With an RIO mortgage, homeowners are able to borrow against their property, whilst making small monthly payments each month which keeps the loan and interest at bay.
The loan is then repaid once the property is sold, when you pass away or when you move into a care home, depending on the product that you opt for.
A retirement interest only mortgage can be cheaper than a lifetime mortgage because there is usually no interest that compounds over months.
However, when it comes to this type of mortgage, homeowners do have to demonstrate that they can afford the monthly interest payments, which is sometimes tricky if you or your partner is retired.
Due to this, your pension income and other financial aspects will be assessed, as the lender will need to be satisfied that you can make the monthly repayments.
What about using savings?
It is often recommended that before borrowing any money, you should always look at the other assets you already own, including your savings.
This could include any investments, ISAs, premium bonds or pension pots.
Of course, keeping your savings untouched can be sensible, as you might want an emergency fund or need money available for future care.
Can opting for equity release restrict your ability to move home?
Taking equity release does not necessarily mean you can never move house, although it can make it harder to move in the future.
Modern equity release products allow you to transfer your equity release plan to another suitable property, subject to the lender’s criteria.
However, it is important to understand that this is not the same as having complete freedom to move wherever you want in the future. For example, your new property might need to meet the lender’s requirements, including being under a certain value.
Likewise, by moving home you might also have to repay some or all of the existing equity release loan.
This is often difficult as it’s hard to predict what will happen in the future. For example, you might eventually want to move into a bungalow, move closer to your family or relocate to a different part of the country.
Before taking out an equity release loan, you should therefore think beyond what you need today and try to think about what you might need or want in the future.
Is equity release ever a good idea?
Yes, it is important to understand that opting for equity release is sometimes the best option available. Calling equity release a last resort should not be confused with calling it a bad product as there are lots of positives to equity release.
There are a number of different circumstances when equity release might be the best option for you.
For example, you might have little income but substantial equity in your home, you might want to remain living in your home and have no desire to downsize.
For a lot of people aged 55 or over, the ability to stay in their home during their retirement is worth more than maximising the value of their inheritance.
Conclusion
Equity release is a great option for anyone who doesn’t want to downsize or move home but needs access to more cash during retirement.
However, it is important to understand that equity release is not for everyone due to the compound interest and fact that it makes it harder for you to move house in the future.
Likewise, there can be a number of different significant setup costs, as well as early repayment charges. For these reasons, equity release is often described as a last resort for some people, whilst it is often the best option for others.
For some people, there might be simpler ways to achieve the same objective without taking out an equity release loan and placing a long term debt on your home.
Before proceeding with an equity release loan, you should compare equity release with downsizing, a retirement interest only mortgage, or look at using your savings.
If you are considering taking out an equity release loan, then you should always take out independent advice, such as the team at Equity Release Warehouse.
Our team of advisers will be able to provide you with free and confidential advice on how much equity you might be able to release, how much compound interest you will likely be charged, what your inheritance would look like and whether or not there are any other options available to you.
References
[2] https://www.ageuk.org.uk/information-advice/money-legal/income-tax/equity-release/
