Four things to consider if you’re thinking about equity release
5 min read
Equity release comes with pitfalls as well as benefits, so there’s a lot to think about. Here are four things to consider before you take the plunge.
Equity release is increasingly popular among older asset-rich, income-poor homeowners who want to access the value in their property.
With banks tightening their lending and affordability criteria, it can be difficult for retirees to remortgage in the usual way. But lifetime mortgages have stepped in to bridge the gap, as they allow borrowers to unlock some of the value of their home without repaying any interest until their house is sold when they die or go into care. They can use the proceeds of equity release to clear an existing mortgage, help a family member on to the housing ladder, or simply enjoy their retirement.
It sounds like a great solution, and it can be for some. If you’re thinking about equity release, here are four things to think about before you do.
The cost of equity release
Lifetime Mortgages are one of the most popular forms of equity release. One of the main issues is that a lifetime mortgage may not typically give you as good an interest rate as you would get on a standard remortgage. That’s because there’s more uncertainty for the lender who doesn’t know when they will be repaid, or whether property prices will fall before then.
According to Moneyfacts*, in September 2020, the average fixed rate on a lifetime mortgage was 4.21%. Check that the terms and conditions allow you to make repayments – some providers may charge an early repayment fee if repaying wasn’t part of your original agreement.
As with any mortgage, you may have to pay an arrangement fee, as well as a survey fee and solicitors’ fees. It’s a requirement that you take financial advice when thinking about equity release, and this may also cost you.
Can you repay the interest on your lifetime mortgage?
Think about whether you could repay some of the interest on a lifetime mortgage while you are alive, rather than allowing it to compound as this will significantly reduce the cost. Some providers will be more flexible than others on repayments, and some will impose limits on what you can repay each year, so check the small print.
Choosing a drawdown mortgage rather than a lump sum mortgage means you only take out what you need, and you only pay interest at the point you withdraw funds, so this could reduce the effect of interest compounding over time.
Impact on your estate when you use equity release
The value of your estate will reduce when you use equity release, which means your beneficiaries will end up with a smaller inheritance. However, you can usually ring-fence part of your property value so you can still pass on some of it to your family.
Reputable equity release providers will offer a ‘no negative equity guarantee’. This means your beneficiaries won’t be responsible for any shortfall if the value of your home drops and there’s not enough left when it is sold to repay the full amount borrowed.
Tax and benefits of equity release
The money you receive from an equity release plan is tax free. However, there could be tax implications depending on what you do with the money. If you took a lump sum and put it into a non-ISA savings or investment account, you could be liable for tax on any interest earned. However, some people use equity release as a way to reduce their inheritance tax liabilities because they are taking money out of their estate while they are alive.
You could also use equity release cash to fund your pension, as pensions don’t form part of your estate and can be passed on without attracting inheritance tax. But bear in mind that, if you receive any means-tested benefits, these could be affected by the cash you get from equity release.
Equity release can be an expensive and risky strategy if you don’t know what you’re doing. And, if you change your mind, it can be difficult to unravel. So, make sure you go in with your eyes open, take your time and, overall, take advice from an independent adviser to avoid costly mistakes.
Hannah Smith is a freelance financial journalist with a background in the trade press. She writes about personal finance, asset management and business for titles including Money Observer, Shares, FE Trustnet and MoneyWeek.
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