Equity release - your options explained

Asset rich but cash poor? The prospect of a financially straitened retirement is tempting more and more of the over 55s to generate money by releasing some or all of the equity in their homes. One equity release scheme provider, Prudential, has predicted the market's value will jump sevenfold to almost £7 billion in the next three years.

Such schemes are becoming more competitive and borrower friendly as more providers enter the market, but generally they still remain an expensive way to raise cash. Also they can be inappropriate; Age Concern has criticised the poor advice and pushy sales tactics associated with some equity release schemes. A survey by the Financial Services Authority (FSA) last year found too many elderly clients were advised to borrow more than they needed against their home's equity; they were then encouraged to invest the surplus in investment schemes, the return on which failed to match, leave alone exceed, the rate of loan interest.

However, as people live longer beyond retirement age, on a static or dwindling income, all the time watching house prices apparently continuing to climb (bar the occasional hiccup), the temptation to release equity will be seen as the answer to a lot of problems.

There are basically two types of equity release schemes (or home income plans as they are often described).

• Lifetime mortgage - this pays out a cash sum or a regular income. The interest on the loan rolls up until death or a move into residential care.
• Home reversion plan - part or all of the home is sold in exchange for a regular income or lump sum and free lifetime tenancy; on death or departure to residential care the home (or relevant percentage share) reverts to the loan provider.

Releasing equity via a lifetime mortgage is sometimes viewed as the better option. For instance, a reported example takes a couple both aged 70 who want to raise £50,000 against their home valued at £200,000. The duration of the loan turns out to be 15 years by which time the house is worth almost £312,000 (3% price rise pa).

The lifetime mortgage route at, say, a loan rate of 6.6% would result in an ultimate debt of £130,415. To raise £50,000 by the home reversion method, the couple would have to sell a 62% share (allowing for costs) of their home, which would net the equity release company £193,190 from the house sale 15 years later.

Some argue that lifetime mortgages are only suitable for those without dependants or not bothered about leaving an inheritance. After all, there is no way of knowing in advance how much will be owed on death. The interest can quickly roll up and after 20 years or so there may be precious little of the house's worth left once the loan is repaid.

Most lifetime mortgages (which are already regulated by the FSA; reversion scheme regulation is expected this year) carry negative equity guarantees. Thus if the loan exceeds the property's value on death, the provider will take the loss and will not chase relatives for the balance. Apart from deciding whether dependants need to be left anything, other costs to consider in setting up a lifetime mortgage are application, valuation and legal fees.

There's also the possibility of a broker's fee (percentage basis). Costs for implementing home reversion plans vary; not all providers charge for valuations (£300 - £500), for example. Most home income schemes on the market have a minimum age for applicants. The house must be owned, of course, with little or no existing mortgage debt and be in a good state of repair. In recent months, with competition hotting up amongst providers, cheaper, more flexible options have become available.

There are now lifetime mortgage deals which offer open-ended drawdown facilities at competitive rates, thus countering past criticism of equity release schemes whereby homeowners were encouraged to withdraw more money than initially needed. There is even a "fixed" lifetime mortgage, where the debt level is set at the beginning and not dependent on the rolled up interest. A debt is fixed at £150,000 on a £200,000 property, for example. Whether the duration of the loan is 15 or 50 years, that's all that's paid back. But the amount of equity release received depends on age when the loan is taken out, say £30,000 at 60 or £75,000 at 85. So it's still an expensive way.

As ever, you should seek professional independent financial advice before embarking on the home income route. Deal only with providers affiliated to Safe Home Income Plans who comply with a code of practice and spell out the benefits, obligations and limitations of such schemes. Remember, once a deal has been signed it may be impossible to reverse at a later stage. Consider alternative ways of funding retirement. The interest only mortgage is a form of equity release. Sufficient income is obviously required to meet the monthly repayments, but there's an upfront cash lump sum which is only reclaimed when the home is eventually sold.

Selling the home now and downsizing to a less opulent residence is another way of releasing equity. Or children could be threatened with no future inheritance unless they pay present day grocery bills and meet the cost of regular overseas holidays!

24 February 2006 © Moneyextra.com

back

Moneyextra.com recommends you should consider taking independent financial advice before acting on any article. Please contact us for help with your individual circumstances if any assistance is required.