How Does Equity Release Work? (Release Equity in Your Home)

Equity release might seem like a good option if you want some extra money and don't want to move house. However, this is a major decision, so should never be taken without independent professional advice. Here we explain what equity release is and how it works, and answer all of the important questions that you might want to ask.

What Is Equity Release?

Equity release is a financial arrangement to help older homeowners turn equity in their homes into tax-free money that they can use as they like, while retaining ownership of their property. It is worth noting that, the money you release will need to pay off any outstanding mortgage first. The rest is yours to spend as you wish, for example on home improvements or to help your family.

There are two main types of equity release: lifetime mortgages and home-reversion plans. The most popular of these is the lifetime mortgage, which is aimed at homeowners aged 55 and over. It allows you to borrow against the value of your home, while retaining 100% home ownership for your lifetime, without needing to make monthly payments.

So taking out one of these mortgages is an increasingly popular way for people aged 55 and over to benefit from the equity they have built up in their homes.

It's important to stress that equity release mortgages and remortgaging to free up equity are not the same thing. If you remortgage, you will have to make monthly payments to cover the cost of your borrowing and the interest.

What Is Home Equity Release?

'Equity' is the value of your home, less any money you owe on it (on your mortgage).

'Home equity release' lets you access some of your equity, while you continue to live in your home. For example, you may want money for home modifications, medical expenses or to help with living costs.

Ways to access equity in your home include:

● Reverse mortgage
● Home sale proceeds sharing (home reversion)
● Equity release agreement
● The Government's Home Equity Access Scheme (formerly the Pension Loans Scheme)

The amount of money you can get depends on:

● Your age
● The value of your house
● The type of equity release

Your decision could affect your partner, family and anyone you live with. So take your time to talk it through, get independent advice and make sure you understand what you're signing up for.

How Does Equity Release Work?

Learn how equity release works

There are two ways to release equity from your home – taking out a loan against part of it, with a lifetime mortgage, or selling part of it, with a home reversion plan.

1. Lifetime Mortgages – For Those Aged 55+

This is the most popular type of equity release. You borrow a lump sum in the form of a mortgage, which is eventually repaid from the sale of your home either when you die or move into long-term care. The amount you can borrow is usually between 18 per cent and 50 per cent of the property's total value – typically the older you are, the more you can release.

The amount you owe will grow with interest, but you can sometimes reduce this by paying off the interest as you go, so it doesn't compound (this is known as an 'interest paying mortgage'). If you choose not to pay off the interest as you go, you will have an 'interest roll-up mortgage'. In this case you will end up repaying more overall, as the interest will compound over time.

Most providers now offer a 'no-negative-equity guarantee', which means the debt will never be more than the sale value of the property. However, this could still mean that all the property's value is used up in paying off the mortgage.

You may qualify for an enhanced lifetime mortgage if you have a serious health condition or an unhealthy habit, like smoking. This can enable you to borrow more, or to pay lower interest.

2. Home Reversion Plans – For Those Aged 60+

The other type of equity release product is a home reversion plan, although these now account for less than 1 per cent of the market. With this type of scheme, you sell part or all of your property to a plan provider, and they will pay you a tax-free lump sum in return.

This lump sum won't be for the market value of your home because the provider is giving you the right to live there rent-free for the remainder of your life. When you die, your property will be sold and some or all of its value will go to the company that sold you the reversion plan, depending on the percentage they bought.

For example, if you sell a 40% share in a £200,000 property in return for a lump sum of £40,000, this cash you receive is at a huge discount to the £80,000 this share is actually worth (at current market prices) – mainly because the provider will have to wait many years to get its money back. Years later, when you die, if your home is eventually sold for £300,000, the provider would then be entitled to £120,000, which is equivalent to 40% of the sale proceeds.

So home reversion plans are better if property prices stay flatter, and worse if they rise substantially.

How Does Equity Release Mortgage Work?

Learn how equity release mortgages work

1. Get Advice

As a first step, you'll need to speak to a financial adviser who's qualified to advise on equity release products. Your adviser will check your eligibility and take the time to understand whether equity release is right for you. Based on your personal wants, needs and financial position, your advisor will give you their recommendation.

2. Valuation and Offer

If you're happy to go ahead, make sure you appoint a solicitor who specialises in equity release to act on your behalf and offer independent legal advice. Your adviser will then help you submit your application to your chosen lender. Your lender will contact you to arrange a valuation of your home. Once your lender has approved your application and completed your valuation, they'll send the offer and terms through to your solicitor.

3. Receiving Your Money

If you're happy with the offer, your lender will release your money to your solicitor. Your solicitor will then release the money to you as you agreed with your lender, for example as one lump sum or the first smaller sum of a series.

How Much Does Equity Release Cost?

Average interest rates on lifetime mortgages are currently around 4.5 to 5%, with the cheapest rates nearer to 4.25%. This is low compared to 10 years ago – but note that they're still substantially higher than the top rates on normal residential mortgages. And just because a deal has a low interest rate, this doesn't always mean it's the best deal.

When weighing up which equity release product would suit you best, remember that the eye-watering price-tag your estate would have to repay comes if you've chosen not to make monthly repayments to reduce the debt, so the interest compounds and compounds.

For example, borrow £20,000 aged 60 at 5.1% on a £120,000 home, and the amount you owe doubles roughly every 14 years. So live until 74 and you owe around £40,000, live until 88 and you owe £80,000.

As well as the actual cost of the interest, you'll have to pay a number of fees. This will likely set you back between £1,500 and £3,000, depending on the type of plan being arranged, and will include arrangement & valuation costs, as well as fees for legal work and a surveyor.

Is Equity Release a Good Idea for You?

Whether equity release is right for you or not will depend on your circumstances. Some reasons to consider it include:

● Your other savings and/or sources of income will not be enough to meet your needs in retirement
● You don't want to (or can't) downsize
● You don't mind reducing your family's inheritance (or you have no beneficiaries)
● An independent financial adviser has told you this option is best for you

Some reasons to choose an alternative to equity release include:

● You can meet your income needs in retirement from other sources
● You have the opportunity to release money from your home by downsizing
● You want to preserve as much of your estate as possible for your family to inherit
● An independent financial adviser has told you this option is not the best one for you

There is much that needs to be considered when deciding whether equity release might suit your personal circumstances. Whichever route to advice you take, you will have the chance to discuss your circumstances and work out if equity release is your best option. It may be the case that there is an alternative to equity release that is a better fit for you, such as remortgaging or downsizing to a smaller property.