If you are in or nearing retirement, you may be considering your options for how you will fund your lifestyle without a salary. Pensions are an obvious source, but increasingly people are looking at equity release too.
Here, we look at what equity release is and how interest rates charged by providers impact these products. We look at what types of equity release there are if a home reversion plan could be a better option, and ultimately why getting as good a rate as possible for these products is essential.
What is equity release?
Equity release is a financial product that allows homeowners, typically those aged 55 and above, to access the value tied up in their property. It provides an opportunity to release a lump sum or regular income from the equity built up in a home without selling the property. How much equity is in the home will depend on how much the property’s price has risen since purchase (if at all) and how much of the existing mortgage a person has paid off.
While this may sound similar to remortgaging, equity release differs because it caters to other financial needs. Equity release is designed for older homeowners who want to access the equity in their property without making regular repayments, including monthly interest payments.
Remortgaging, on the other hand, involves replacing an existing mortgage with a new one, often with different terms or interest rates, and is typically used to secure better terms for the original loan (such as lower fixed interest rates or a better variable rate). Depending on individual circumstances, a person may also want to remortgage to release funds or consolidate debts. Unlike equity release, remortgaging requires ongoing repayments and is available to homeowners of lower age groups.
Why do people use equity release?
People use equity release for various reasons. One common motivation is to access the value tied up in their property to supplement their retirement income or improve their standard of living.
It can also fund specific goals, such as home renovations, debt consolidation, or gifting to loved ones. Additionally, equity release allows homeowners to remain in their property and avoid downsizing or moving, providing the peace of mind of staying in a familiar environment while accessing the wealth accumulated in their home.
What’s a lifetime mortgage?
A lifetime mortgage is the most common type of equity release in England and other parts of the UK. It involves taking out a loan secured against the property’s value, with interest accruing over time. The loan and accumulated interest are repaid when the homeowner either passes away or moves into long-term care. The property is typically sold to settle the debt and the roll-up of interest payments that weren’t made as part of the agreement.
What’s a home reversion plan?
A home reversion plan is a financial product that allows homeowners to release equity from their property while retaining the right to live in it. It is primarily available to older homeowners, typically aged 65 or above.
In a home reversion plan, the homeowner sells a portion or the entire ownership of their property to a home reversion provider in exchange for a lump sum payment, regular income, or a combination of both. The homeowner continues to live in the property as a tenant without paying rent, but they no longer fully own the home.
The amount received from the home reversion provider is generally less than the market value of the portion of the property sold. This is because the homeowner retains the right to live in the property for the rest of their life or until they move into long-term care. Upon the homeowner’s death or when they move out, the property is sold, and the home reversion provider receives their share of the proceeds. As a result, the homeowner can only pass on the remaining portion of the property to their heirs.
What’s the difference between a home reversion plan and an equity release loan?
While home reversion plans and equity release are both financial options that allow homeowners to access the equity tied up in their property to use in later life, there are some critical differences between the two. Many of those differences are impacted by the interest rate you are charged and will affect which option you finally choose.
Home reversion plans involve selling a portion or all of the property to a reversion company while retaining the right to live in the home rent-free. The homeowner receives a lump sum or regular payments in exchange for a share of the property sold.
Equity release loans, on the other hand, allow homeowners to borrow against the value of their property without selling it. The loan is repaid either when the homeowner moves into long-term care or passes away, typically through the sale of the property.
Both options can provide individuals with a source of cash or income in retirement. Still, they come with important considerations, such as the impact on inheritance, eligibility criteria, and potential effects on means-tested benefits. It is crucial to seek professional financial advice and carefully evaluate the terms and implications before proceeding with either option.
Understanding equity release – how it works in practice
Before choosing to get cashback from your home for your retirement, it’s crucial to understand how these products work first – a considerable part of which is comprehending how interest rates affect you.
Assessing eligibility and property valuation
When assessing eligibility, lenders consider factors such as the homeowner’s age, property value, and loan-to-value ratio. An independent surveyor determines the property’s value, which is crucial in determining the amount of equity that can be released.
If you disagree with your provider’s valuation, you have the right to challenge it. Some lenders may have a formal appeals process where you can provide additional evidence or seek a second valuation. Alternatively, you can seek independent advice to help negotiate a fair valuation.
Releasing equity and repayment options
Once approved, the homeowner chooses whether it’s better for them to receive the funds as a tax-free lump sum, in regular monthly payments, or a combination of both. Releasing funds over time is a drawdown lifetime mortgage and can minimize the interest you pay over the loan. While repayment typically occurs when the homeowner dies or moves into care, some plans offer the option to make interest repayments to prevent the debt from increasing.
Impact of interest rates
Interest rates are vital as they determine the amount of interest that will accumulate over time. Lower interest rates result in less overall interest to be repaid, making it a more cost-effective option. It’s essential to compare rates from different lenders to find the most favorable lifetime mortgage interest rates with terms that work for you.
Before proceeding, seeking equity release advice from an independent financial adviser or a specialist equity release adviser is highly recommended. They can provide personalized guidance, assess the suitability of equity release, and help find the best deals available in the market. They will talk in more detail about how interest rates play a significant role in the cost-effectiveness of equity release.
Equity release mortgages and the interest rate you secure are typically not dependent on your credit history. Lenders primarily assess your home’s value and age when determining eligibility for equity release. As a result, even if you have a poor credit history, you can still qualify for equity release, making it an accessible option for many retirees.
What are the best equity release interest rates at the moment?
Interest rates play a crucial role in equity release as, since interest is compounded, even minor rate differences can significantly impact the final repayment amount. Interest rates on equity release products can vary a lot depending on the provider and the plan’s specific terms. That’s why shopping around and comparing offers from different lenders is so essential to find the most favourable rates.
Remember, the best rate for you may not be the lowest rate you are eligible for. Other mortgage product terms make a higher rate more suitable for you. For instance, you may find that you want a lump sum instead of a drawdown lifetime mortgage, for which you need to accept a higher MER (monthly equivalent rate).
When browsing the market for the best equity release interest rate, it’s a good idea to consider the advantages of why you are doing it in the first place. Doing so may mean you choose a product with a slightly different repayment structure, such as repaying the interest of the equity release.
Access to tax-free cash
Equity release provides homeowners with a valuable source of tax-free cash, allowing them to access the wealth in their property. This can be particularly beneficial for retirees with limited income who want to enhance their lifestyle, make home improvements, or fund important expenses such as healthcare or travel.
One significant advantage of equity release is that homeowners can continue living in their property for as long as they wish. There is no need to downsize or move out, providing peace of mind and the ability to stay in a familiar and comfortable environment.
Equity release offers flexibility in how homeowners access their funds. Depending on their needs and preferences, they can receive the maximum amount as a lump sum or regular income through a drawdown lifetime mortgage – or a combination of both. This flexibility allows individuals to tailor the release of equity to meet their specific financial goals, whilst finding a product at an interest rate they are comfortable with.
Unlike traditional mortgage products, an equity release scheme typically does not require monthly repayments. This can be particularly advantageous for retirees with limited income or who prefer not to have ongoing financial obligations. That’s not to say that the interest rate charged should be disregarded when applying for these products. The loan and the accrued interest are repaid when the homeowner passes away or moves into long-term care, so keeping the rate as low as possible is still crucial.
Protection of inheritance
Equity release plans often offer the option to protect a portion of the property’s value as an inheritance for loved ones. This ensures that homeowners can leave behind a legacy for their families while still accessing the funds they need during their lifetime whilst reducing inheritance tax in the future.
If property values increase over time, homeowners who have taken out an equity release plan can benefit from this growth. As the property’s value rises, the equity available for release also increases, providing additional financial options in the future.
Of course, these products are not without their drawbacks. Try to remember them when searching the market for a product that works for you.
One of the main disadvantages of equity release is that it reduces the total amount of inheritance that can be passed on to loved ones. As the loan and accrued interest are repaid from the sale of the property, there may be less remaining value to leave behind as an inheritance. Finding a loan with the lowest interest rate reduces the impact of lower inheritance.
Equity release is a long-term commitment that can have a significant financial impact. The interest on the loan accumulates over time, potentially resulting in a substantial debt to be repaid in the future – especially if a high-interest rate was all that could be secured. This can reduce the amount of equity available for other purposes and affect the financial well-being of future generations.
Taking out an equity release plan can impact means-tested benefits that individuals may be receiving. The released funds could be considered an asset and may affect eligibility for certain benefits such as pension credits or council tax reductions. Considering the potential impact on benefits is essential before proceeding with equity release.
Some equity release plans may have early repayment charges or penalties if the loan is repaid before a specific period. These charges can be significant and restrict the flexibility to repay the loan early or switch to a different plan or provider. It’s crucial to carefully review the terms and conditions of the plan and consider any potential charges.
In certain situations, the property’s value may not keep pace with the accrued interest on the loan. This can lead to negative equity, where the outstanding loan amount is higher than the property’s value. In such cases, limited options may be available for the homeowner and their family. It’s possible to take out negative equity guarantees to work around this – though they come at a price.
Equity release can limit future housing options. If homeowners wish to downsize or move to a different property in the future, the outstanding loan and accrued interest must be repaid. This can restrict flexibility and affect the ability to move or relocate as desired. Again, this is why shopping around to find a product with the lowest rate possible for your needs is so crucial.
Choosing interest rates for equity release
Ultimately, equity release allows homeowners to access the value tied up in their property without selling it. As the debt is often settled when that person passes away or moves into long-term care, it can feel a little like ‘free money’, especially as it is tax-free. It can be tempting to pursue the path of equity release with little research or due diligence into the interest rates available or without seeking financial advice.
However, you may want to leave your family with some inheritance. In that case, trying to secure the lowest interest rate you can with a product that still answers your circumstances is crucial. Not repaying interest on these loans soon adds to a substantial debt through compounding. Over time, it can quickly eat away at the remaining equity you have in your property.
That’s not to say equity release is not a good idea. It definitely can be, particularly if you have owned your property for a long time and seen its price rise. In all circumstances, though, you must find a solution that works for you – at a price, and an interest rate, that minimizes your debt.