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The pros and cons of equity release

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For a rapidly growing number of retirees, their home isn’t just a source of comfort, security and familiarity. Thanks to the advent of equity release opportunities, it’s also become an important source of their day-to-day income.

Coming in various forms, but mostly as lifetime mortgages, equity release products were the fastest-growing segment of the mortgage sector in 2016. Customer numbers jumped by more than a fifth to 27,534, taking out an average lump sum of £92,376, according to the Equity Release Council.

The way equity release works is relatively simple. With a lifetime mortgage, you can take out a loan against your property up to a maximum of around 50% of its value (dependent on the loanee’s age and value of the property). The loan, plus associated interest costs, is repaid when your home is sold, either after you die or move into permanent care.

A less popular form of equity release, a home reversion plan, involves selling a portion of your home to a company upfront. On death or moving into permanent care, the company gets the bit you sold upfront, meaning the property itself also has to be sold.

Why is equity release so popular?

Given a surge in the number of Baby Boomers reaching retirement – over 15 million British citizens are now aged 60 and above – it’s no surprise that equity release products are all the rage. Not only can they generate a reliable source of income while allowing folks to maintain a comfortable lifestyle in their own homes, they can also provide a one-off funding bump to perhaps pay off interest-only mortgages, renovate that rickety kitchen or make that dream holiday into a reality.

A growing number of parents are tapping equity release to help their children onto the property ladder, figuring that offering a lump sum when they die, while larger, could come too late.

And the equity release market has grown up a lot in the past five years. Lending standards have improved and competition between providers has brought interest rates down. Products, though, still have their pitfalls. And equity release certainty isn’t for everyone.

Does equity release make sense for me?

Equity release isn’t usually suitable for property owners that have lots of spare cash lying around, or other investments like shares and bonds. Those assets can generate adequate income in their own right, lessening the need for a loan.

People wondering if they have enough to fund a comfortable retirement should consult a financial adviser, who can help evaluate if equity release is the right route. But as a general rule of thumb, it’s recommended that you’ll need between 50% and 65% of your final salary, after tax, to enjoy a similar standard of living.

Always talk to a qualified financial adviser when making these decisions; they will be able to help you understand whether equity release is right for you. Depending on your product and plan, equity release can be an expensive way to borrow.

Could a lifetime mortgage wipe out my kids’ inheritance?

Be careful: interest compounded over many years adds up. A rate of 5.5%, for example, compounded annually on a £100,000 lump sum would add interest costs over a ten-year period of around £71,000.

That could mean there’s not much value left in your home to pass on to loved ones, especially if house prices have stagnated or fallen.

The good news is that reputable equity release products come with a “no negative interest guarantee”. That means, should house prices collapse or if the rolled up interest is higher than the house price, your beneficiaries will never owe more than the value of the property.

There’s also an assortment of products to choose from that can help you reduce expenses, for example some allow you to repay 100% of the monthly interest on the loan for a period of your choice. It’s important to work with your financial adviser to find the right product and plan for your situation.

How can I keep those costs down?

People wanting to avoid interest costs entirely could always opt for the route less traveled: a home reversion plan. A downside here is that relatives won’t get to pocket any increase in the value of the portion of the home that was sold.

A more popular option is to select a lifetime mortgage with a “draw-down” plan. In this instance, funds are released in regular bursts, perhaps monthly. Interest is only charged on the money that’s drawn down, shrinking the overall cost.

With lifetime mortgages, depending on the product, interest payments can also be made at regular intervals, rather than all coming in one big heap at the end. And customers willing to take the risk can opt for a variable interest rate product.

Some providers offer even more flexible solutions. Some providers may allow variable-rate customers to fix how much interest they pay in regular increments, buffering them should rates rise.

How will equity release affect my pension benefits?

Some state benefits are affected by equity release and some aren’t. It’s crucial to take a close look at what kind of payments you’re receiving, or expect to receive, from the government.

Thankfully, for those over 65, state pensions aren’t affected. But many means-tested benefits, such as pension credits for lower income earnings, could be lost.

You should also weigh whether you’ll be entitled to aged-care support and, if not, how equity release could factor into your care plans.

Is staying at home better than downsizing?

Of course, an alternative way to raise funds from a property would be to simply sell and buy a cheaper home elsewhere, pocketing the difference. Anyone thinking of downsizing to a flat, however, should be mindful that upkeep levies charged by property managers can run into thousands of pounds per quarter.

Homeowners should also think how much their own personal needs may change. Planning to stay in a home with lots of stairs, for instance, may prove unwise, unless you can afford a stair lift in the event of surgery.

You should also consider whether your current location gels with the kind of lifestyle you want in retirement. Are you close to family and friends? Are shops and entertainment precincts suitable for seniors nearby? If they are, then equity release might be for you.

Note: Whilst we take care to ensure Hub content is accurate at the time of publication, individual circumstances can differ so please don’t rely on it when making financial decisions.