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Home Equity Release Loan - Using your home as capital


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Using your home in pension planning is becoming more common. Equity release covers the main ways in which people extract cash from their property while continuing to live in it. This guide explains how home reversion plans and lifetime mortgages - the commonest forms of equity release - work and what you need to watch out for with both of them.

What is equity release?

Equity release is the name given to the process which allows you to release equity that has been storing up in your home. However, there is more than one way of doing this and it is easy to become confused. The term is most commonly used for borrowing more against the value of your home by taking a 'further advance' on your mortgage. Many homeowners choose to take a further advance - in other words 'up their mortgage', increasing their outstanding debt - at the same time as they remortgage to a different lender or even to a different deal with the same lender.

But 'equity release' is also an industry in its own right. It is aimed at retired homeowners who are cash-poor but equity-rich. According to the Council of Mortgage Lenders, UK pensioners are sitting on a collective £1.1 trillion of equity in property (Source: Council of Mortgage Lenders, 03/08/06).

Equity release schemes allow you to sell or borrow against a proportion of your home in return for a cash lump sum that you can spend over the remainder of your life. Equity release schemes do not require that the loan is repaid within your lifetime. Similarly, if you sell a part of your house, it will not be reclaimed by the company until you die or go into a care home at which point the property is sold.

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Do I qualify for equity release?

There are currently around 40 different equity release plans on the market available from more than 20 providers. Criteria for these all differ but, according to one provider, Tomorrow (formerly GE Life), potential customers will need to:

  • Be aged at least 55 to 60, depending on the scheme.
  • Be no older than 95
  • Own a home outright that is worth at least £30,000 to £50,000
  • Be looking to raise at least £25,000 to £30,000
  • Own either a freehold property or one with a long lease that is made from conventional bricks and mortar. It must also be in good repair
  • Have no tenants living in the property
  • Want to stay in their home for as long as they are able.

If you tick all these boxes and are still interested, you need to familiarise yourself with the different schemes available. There are two basic kinds of equity release schemes: lifetime mortgages and home reversion plans.

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How do lifetime mortgages work?

Lifetime mortgages are currently by far the most widespread form of equity release and work as follows; a homeowner can mortgage a proportion of their property and the level of which will depend on their age. The older you are the more you can mortgage. For example, a lender may be willing to lend a maximum of 20% of the property's open market valuation to a 60-year old but will lend 50% to a homeowner of 90 or older. This is because - brutal as it may seem - the younger the homeowner, the longer they are expected to live and therefore the greater the potential interest bill the equity release firm can pocket.

The money released can either be paid as a cash lump sum or as a monthly income. Either way it is totally tax-free. The mortgage is repaid to the equity release company either when you sell the house yourself or when you die or go into a care home. In either of the latter events, the sale must typically take place within a year.

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How is the interest on a lifetime mortgage calculated?

Lifetime mortgage providers offer fixed rates of interest on their loans which will not change within the life of the mortgage - and therefore within your life too. Traditionally, this home equity loan rate was a lot more expensive than on residential mortgages but - due to increasing competition in the market - the gap is closing.

For example, Standard Life offers a rate of 6.05%, Just Retirement offers a rate of 6.15% and Bradford & Bingley offers a rate of 6.16% (source: SHIP 21/05/2007). Although no money is repayable in your lifetime, this interest 'rolls up' so that, effectively, interest becomes payable on interest. This compound interest can be a very expensive affair.

Even if you only mortgaged the minimum 20% of your property, if you live long enough the interest could end up eating into the entire value of the property. For example, borrowing 20% of £100,000 - £20,000 - at 6% at the age of 60 would see your debt pass the £100,000 mark just before you reach the age of 89. You might reasonably hope that house prices would also have risen in the intervening period but that's by no means a certainty.

However, these days, most lifetime mortgage schemes come with a guarantee that ensures you will never be put in a situation of negative equity whether it occurs as a result of a downturn in house prices or the borrower living to a ripe old age150.

Therefore, the worst situation your family could find themselves in when you die is that 100% of the property is owned by the lifetime mortgage provider. To be absolutely sure that the scheme will not take your property into negative equity, you should use a company that is a member of SHIP (Safe Home Income Plans) . This is a voluntary regulatory body but represents more than 90% of the equity release sector.

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Should I opt for a lifetime mortgage with drawdown?

A drawdown facility means that, even though you are still paid a lump sum for whatever proportion of mortgage you opt or qualify for, some of this can be held back until you need it - rather like having an overdraft facility that you do not use. Only when you tap into this drawdown and actually take the funds do you start being charged interest. This means that, ultimately, your family could be left with more of the property when you die or go into a home and the property is sold.

At first, drawdown facilities on lifetime deals came with restrictions. For example there was a time limit from when you completed the deal to when you could access the drawdown - typically either 10 or even just five years. However, flexible drawdowns are now available that allow you to keep your money aside for any length of time. Some schemes even allow your drawdown funds to grow (Prudential, for example, offers 1% growth per annum) to reflect the bigger proportion of the property you may borrow each year you get older.

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How do home reversion plans work?

Home reversion plans represent the alternative type of equity release scheme, and, according to statistics, are currently far less popular, accounting for just 6.8% of all equity release schemes (Source: SHIP 29/01/2007). Home reversion plans do not involve mortgages - the homeowner simply sells a proportion of their home. How much you are able to sell will hinge on your life expectancy; so age, health and gender will all be taken into account. With this type of scheme it is possible to sell up to 100% of the open market value of the property. The money released can either be paid as a cash lump sum or as a monthly income. Again, it is totally tax-free either way.

As a home reversion plan is a 'sale' as opposed to a mortgage, the equity release provider does not make money from long-term compound interest and therefore needs to find another way of charging.

In the first instance, they achieve this by paying a great deal less for the proportion of your home than it would be worth on the open market. Typically, a homeowner is paid anywhere between 30% and 60% of the value of the proportion of the property although the exact amount will depend on the provider and the customer's circumstances.

So in the worst case scenario, if you wanted to sell 50% of a property that is worth £200,000 you would receive £30,000 (30% of half the value). Although this might sound like a terrible deal, remember the lifetime rent payable on the part of the property you will not own, is factored into the price.

The second way home reversion plan providers make money is on the equity of the part of the property they come to own. Although you can live in your own home until you die or go into care, when the property is sold, the provider will reclaim the same percentage they were sold. If current house price rises are anything to go by, it could, therefore, be worth a lot more than they paid for it.

Home reversion plans became formally regulated in April 2007.The previous lack of regulation meant only a handful of the big names in the equity release sector offered home reversion schemes. Ahead of the introduction of the new regime, the Financial Times (21/10/2006) claimed that regulation would bring a revival to the products, helping them to become more widely available as well as more competitive.

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What sort of fees will equity release schemes charge?

Lifetime mortgages : Taking a lifetime mortgage is the same as taking any other kind of mortgage when it comes to fees. You will need to pay for a valuation, which, depending on the value of the house, typically costs between £200 and £500. There is also an arrangement fee (£595 in the case of Prudential). This will include the cost of the provider's solicitors although - as stated by SHIP's code of conduct - you as the client will need to seek and pay for your own legal advice too. As is usually the case with standard mortgages, any fees may either be paid upfront or added to the loan.

Home reversion plans : These products are somewhat pricier. Norwich Union's scheme comes with an application fee of £600 and a valuation fee of between £165 and £835 depending on the property value. The provider's own solicitor costs are £350 plus VAT. And clients will then need to pay for their own legal costs in addition to this. Fees must be paid separately and cannot be factored into the cost of the proportion of the property being sold.

Costs that are factored into the deal are two guarantees that some providers insist are taken. This is the Inheritance Protection Guarantee (which guarantees a minimal payment if client dies within first four years) and the House Price Inflation Guarantee which allows the homeowner to share in any exceptionally high HPI over the life of their plan. Some plans allow the customer to proceed without these guarantees but will pay themselves more upfront as a result

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What are the benefits of lifetime mortgages?

House prices have risen by more than 190% in the 10 years to Q1 2007 (Source: Halifax House Price Calculator), and although this doesn't mean that they will continue to rise in the future, taking a lifetime mortgage means that you can still benefit from any further rises. It also means that you may have the opportunity of releasing further equity some years down the line.

Lifetime mortgages come with the armour of industry watchdogs promoting fairer and more transparent deals. For example, alongside standard residential mortgages, lifetime mortgages came under the jurisdiction of the Financial Services Authority (FSA) back in November 2004. And as a lifetime mortgage constitutes a 'financial product' there is also well-trodden path to legal recourse if you are unhappy with your lifetime mortgage. Customers can take their complaint to the Financial Ombudsman Service (FOS) .

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What are the pitfalls of lifetime mortgages?

When comparing fixed interest rates on lifetime mortgages, bear in mind that what you are looking at may not be like for like. Firstly each provider is legally obliged to provide an Annual Percentage Rate (APR) - which incorporates all charges into a yearly cost - as well as the more generally recognised headline rate. But even when comparing headline rates, bear in mind that, confusingly, some will be calculated on a monthly basis and some on an annual basis.

  • More confusing still, unlike residential mortgages where a shorter-term calculation of interest is financially preferable (daily is best), with lifetime mortgages - where interest rolls up and is not repaid - annual interest calculation provides the best value.
  • If interest rates fall over the course of your lifetime you could end up fixed into uncompetitive long-term borrowing.
  • Lifetime mortgages really are for life. Providers will charge very hefty premiums if you want to repay your lifetime mortgage in the first five or even 10 years.
  • If you have previously been in receipt of any state benefits, the fact that you now have a tax-free income or lump sum of cash in the bank, could mean that you no longer qualify.

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What are the benefits of a home reversion plan?

The biggest and most obvious plus to a home reversion plan is that you can be sure of how much inheritance you will leave to your children. Even if you sell 75% of your home, you can rest in the knowledge that, whatever happens, there will be 25% of the property left to give to your children when you die - and at the (then) current market value.

This of course, can also reduce or even eradicate Inheritance Tax liabilities, which currently kicks in on estates worth over £300,000 (tax year 2007-2008).

Owning less - especially if your sale proceeds from the home reversion have been spent may also put you in a better position when it comes to being means tested for care homes.

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What are the drawbacks of home reversion plans?

Charges on home reversion plans are expensive. You will be looking at set-up fees of between £1,000 to £1,500 as well as valuation and legal fees which will be priced according to your circumstances.

Although it might be considered academic, you no longer 'own' your own home. Even though you are 'renting' the part of your home that you have sold, you will still be responsible for repairs and maintenance to the property in its entirety.

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How can I release equity from buy-to-let properties?

The very latest scheme on the equity release market allows homeowners to release a lump sum from a second home, such as a buy-to-let property or holiday cottage. Only a handful of such schemes are currently available.

Schemes allowing you to release the equity from second homes are only available as a lifetime mortgage and could prove attractive to people who would like to supplement their pension income without having to sell up. This could also mean ducking out of a large Capital Gains Tax bill. The interest rates are fixed and, like the residential version of a lifetime mortgage deal, offer a 'no negative equity' guarantee.

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How do I go about taking equity release?

Whichever scheme you opt for, SHIP-regulated equity release providers will insist that you seek your own independent advice. An adviser will take you through which kind of scheme is best suited to you, your finances and circumstances and, if indeed, you should be taking a scheme at all. Many providers insist that family members are also present in the initial meetings as they are the party that will be affected most.

Equity release is such a minefield it's a good idea to choose an adviser that specialises in that particular financial area. Look out for advisers that hold the Certificate in Lifetime Mortgages (CeLM) or the Lifetime Mortgage Activities exam (CF7) from the Chartered Insurance Institute.

Both lifetime mortgages and home reversion plans are long-term, complex legal arrangements, and expert independent legal advice should always be sought before entering into any agreement.

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What are the alternatives?

Before you go ahead with any equity release plan, even the providers (if they are SHIP-registered that is) will want to see you have exhausted every other option. The schemes are expensive, permanent and can potentially take away everything you have worked for in a flash. However, for homeowners in the right circumstances - living in an equity-rich property with no family for example - they can provide the key to a more enriched and fulfilling retirement.

Nevertheless, make sure you have looked at the alternative ways of accessing money before you even enter the equity release route. For example:

  • You should make sure that you claim every benefit you are entitled to, such as Pension Credit (call the helpline on 0800 9991234 to find out if you qualify). But there are 20 different state benefits available to pensioners, according to the Department of Work and Pensions, and not all of them are means-tested.
  • Grants and financial assistance may also be available for pensioners to make essential repairs to their home for example. Visit www.adviceguide.org.uk to see what is available and if you will qualify.
  • You could also downsize your current home, releasing the equity that has accrued, in a way which will be tax-free.
  • Although many pensioners already live on a tight budget, there may be extra saving opportunities that have been missed, such as switching fuel, telephone or insurance providers.
  • It is usually a good idea to exhaust all other savings and investments before opting for equity release.

18 June 2007 © Moneyextra.com

 

Our senior editor Robin Amlôt 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.