Equity Release Explained: Just How Does It Work?

If you own a property, either outright or with a small outstanding mortgage, you have a built up a store of equity that can be released to provide a lump sum, ongoing income, or both.

This guide will aim to answer all of your burning questions regarding equity release starting from the basics and progressing to every little detail imaginable.

What Is The Process?

FAQs

What Are The Alternatives?

How To Choose

What Is Equity Release?

Your home, or other property you might own, has an intrinsic monetary value attached to it and this product effectively allows you to liquidate some of that value and turn it into cash.

By signing up to an equity release scheme from one of the many different providers on the market, you will choose between a lifetime mortgage and a home reversion plan, both of which will be explained in more detail in the upcoming section.

Either way, you can unlock a percentage of the value that is tied up in your home and use the money for a purpose of your choosing.

The types of companies that offer plans of this nature are varied; they are regulated by the Financial Conduct Authority and must be registered in order to legally sell these services.

Reputable companies will also be signed up to the Equity Release Council (ECR) which is the industry body representing the whole sector.

What Types Of Equity Release Are There?

The schemes on offer come in two types as mentioned above. We recommend that you carefully read through the forthcoming details of each before deciding which best matches your preferences and requirements.

Lifetime Mortgage

Much life a traditional mortgage that you get when buying a property, a lifetime mortgage is a loan that borrows against the value of your home. Interest is charged much like any other loan, and this is typically added to the overall repayment amount (although you can opt to pay the interest in monthly instalments).

When the property comes to be sold, either upon your death or through choice, the mortgage and any accrued interest is paid off, with the remaining sum going to your beneficiaries.

You will need to be at least 55 years of age to get a lifetime mortgage; if there is more than one person involved, this applies to all parties.

The amount you can borrow will depend on factors such as the value of your property and how old you are when you apply. It is possible to borrow as much as 50% of the market value of your home, although typically it will be more like 20% to 25%.

There are three variations of a lifetime mortgage which are as follows:

A roll-up mortgage: the equity released is paid to you either in one go or in regular instalments and the interest is added to the overall loan amount. Both the original sum and the interest have to be repaid upon the sale of your home.
A fixed repayment lifetime mortgage: the equity is released and paid to you as above, only this time the amount to be repaid is agreed in advance by you and the lender. It will be higher than the sum raised through the initial release and is once again repaid when your home is sold.
An interest only mortgage: equity is released in the same way as in the other two instances, but this time you pay back the interest on a monthly basis rather than let it get added to the overall value of the loan.

You may be asking yourself what the advantages and disadvantages are of each type. Well, we’ve already thought of that and put together a little list for you:

One of the major pitfalls of a roll-up mortgage is the effect of compound interest. When this comes into play, you might find that the total amount to be repaid is double or even triple that which you released in the first place.
The fixed repayment option allows you to know exactly how much will be owed at the time the property is sold, meaning you do not have to pay any attention to the effect of compounding.
A downside of the fixed repayment option is that you might pay a much higher effective rate of interest if you die earlier than expected because you have already agreed how much is due to be repaid. Conversely, you might benefit if you live longer than the lender expects.
If you pay off the interest as you go, then upon selling the property, only the original amount of equity released will need to be repaid. This avoids the drawbacks associated with compounding.
Paying the interest as you go will mean that you have to manage your money to ensure that you can afford these payments. A potential problem if you intend to use equity release as a means of income is that interest payments will only serve to reduce the amount you receive.

As with any type of credit, it is always wise to compare every viable option out there to ensure that you get the best deal. There are, however, some things that you should look out for:

A no negative equity guarantee: this is a vital component of any equity release product; it means that the amount required to be repaid will never be higher than the value of the property upon its sale. Every provider that is signed up to the Equity Release Council must provide one, but there are some less trustworthy companies out there so if this it not in the contract, walk away.
A portable deal: you might find that you live with a lifetime mortgage for quite a number of years and if you think that you might want to move house in this time, you should make sure that you sign up to a scheme that is portable. This means that the loan can be transferred to your new property instead of having to be paid off.
Type of interest: if you opt for an interest only mortgage, you will want to know whether the rates are fixed, capped or variable. If interest rates rise, your repayments might become unmanageable.
Converting between types: some companies will give you the option to convert one type of lifetime mortgage to another. This will almost certainly be to switch between interest only and one of the other two options. This gives you the option to pay off the interest while you are still working, for example, and then switch when you retire (helping you to avoid some of the effects of compounding).

Home Reversion

The second type of equity release comes in the form of a home reversion. What this means is that you sell a part, or all, of your home in return for a cash lump sum or a regular income. You are allowed to remain living in the property, either without paying any rent or paying a fairly tiny amount thanks to a legal document called a lifetime lease.

The major downside of home reversion is that you will not be paid the market rate for the part of your property that you sell. Instead, you will get a lower sum, often significantly so. How this works is that you might receive 25% of the market value of the property, but have to hand over 75% of the equity contained within it.

The percentage of the value of your home that you will have to surrender depends on how much money you wish to receive and how old you are. How much you get is related to how old you are and how long the purchasing company expects you to live. Typically, the younger you are, the more you’ll have to give away in percentage terms relative to what you receive.

Home reversion plans are generally worse value for money in the long term than lifetime mortgages. People who might want to consider this option include those who want the largest possible lump sum or those with little need or desire to leave the property to beneficiaries when they die.

The minimum age requirement for a home reversion plan is usually 65, but the older you are, the better deal you will be offered.

What Is The Process Of Equity Release?

When you first decide to investigate equity release, you will need to speak with an independent adviser who can guide you through the process.

They will look at your financial situation and work out whether or not equity release is a suitable product for you. If it is, they will compare the available deals and discuss the costs and implications of taking out such a product. They will also provide you with a Key Facts Illustration with all of the details.

Assuming you are happy with the recommendations being put forward, your adviser will help you to fill out an application form and send it to your chosen provider.

The provider will arrange for a surveyor to come and value the property and you will then receive an offer letter telling you how much you can release. Your adviser will walk you through everything in this letter to ensure that you are fully aware of all the features and risks.

If you are happy to proceed then you will have to sign to say that you accept the offer being made. After some checks to ensure your legal ownership of the property, the money will be released to you.

How Long Does It Take?

From the time that you first contact a financial adviser to get details of the schemes available, you can expect to wait between 8 and 12 weeks before you receive either your lump sum or your first regular income payment.

Of course, this reflects a deal that is free from any major complications and is based on the swift signing and sending of documents. If you choose to think for a while, any time spent doing so needs to be added to the above estimate.

What Are The Costs Involved?

The cost of an equity release plan is not fixed and will vary depending on a number of things. A rough guide for most circumstances is between £1,200 and £1,500 and this is made up of the arrangement fees paid to the provider, the legal fees paid to your adviser/solicitor, the cost of valuation, and the cost to you of ensuring the property is fully covered by building insurance (normally a condition of lending).

Equity Release FAQs

There is an almost endless list of potential questions that might be asked with regards to equity release schemes. While we will do our very best to cover as many as possible, we recommend that you speak to an independent financial adviser to ensure that you fully understand the implications before signing any contract.

Can I Release Equity If I Have An Outstanding Mortgage?

If you are at an age where you would like to release some of the equity in your home, but you are still in the process of paying it off with a conventional mortgage, you could still be able to.

Most providers will insist that you use any cash received to first pay off the outstanding balance on your mortgage, but you will be free to do whatever you like with the remaining amount.

Bear in mind that your mortgage company may add early repayment charges if you go down this route, so find out what these are likely to be prior to arranging anything.

Can I Release Equity To Buy Another Property?

By and large, you are free to do whatever you like with the equity that you release from your home. If this means buying another property, you should not find yourself restricted by the scheme itself.

Depending on exactly what you want to achieve, however, you may find that it is difficult or impossible to buy that second property.

First of all, the size of the lump sum you receive will make a difference. If you are able to pay for the second property outright, you can go ahead and make the purchase. If, however, you need to get a mortgage to help pay for it, your age might prevent you from doing so. Many mortgage companies will flat out refuse a mortgage for people over a certain age, although if it is only a small mortgage with a short repayment term, it still might be possible.

If, on the other hand, you are looking to help your children to purchase their own home, you can use the equity released as a deposit or as part of the new breed of family mortgages.

Can I Release Equity From A Buy-to-Let Property?

If you own a property that you currently let out to a tenant (and either own it outright or are prepared to pay off the mortgage as discussed above), things get a little complicated. It might be possible, but there are almost certainly better ways than through an equity release scheme.

You could just sell the property which would release 100% of the value at market rate. The downside is that you would lose out on any increase in the value of the property and, of course, the rental income being generated.

Alternatively, thanks to this assumed income in the form of rent, you could be eligible for a buy-to-let mortgage although age restrictions might apply. You could take out a mortgage of £40,000 over 10 years, for example, and use the rental income to pay it back while spending the money on whatever you like.

What Are The Income Tax Implications?

The money that comes from releasing equity in your home is not subject to income tax regardless of whether you take it as a lump sum or in regular payments. What you do with the money afterwards – such as investing it, buying an annuity, or simply saving it (except in an ISA) – can lead to income tax being charged.

Can Equity Release Reduce Inheritance Tax?

Both types of equity release plan effectively reduce the size of your estate and thus can be used to mitigate inheritance tax that might be paid by your beneficiaries. At the time of writing, inheritance tax is 40% on the value of an estate over and above the £325,000 threshold.

So a property worth £325,001 or more will result in an inheritance tax bill needing to be paid.

If you release equity now, then upon your death, part or all of the proceeds of the sale of your home will go to the equity release company which leaves less of an estate to be inherited and will either reduce or avoid the tax burden.

What Effect Will Equity Release Have On My Benefits?

Depending on whether you are over or under the state pension age, you may be entitled to, and receiving, one or more types of government benefit. When you take equity from your property, either as a lump sum or regular income, you may find that your entitlement changes.

It is worth noting that this only applies to benefits that are means tested – it does not impact any benefit whose provision is not dependent on the claimant’s income or capital.

The question of how signing up for an equity release product will affect the types and amount of benefit you receive is not a straightforward one. There are multiple considerations to make and these should always be discussed by the person selling you the plan.

Here is a list of some of the main benefits that can be affected by your release of equity:

Pension Credit – this comes in two distinct parts: Guarantee Credit and Savings Credit. They are designed to ensure that the income received by a household reaches a minimum set amount.

Equity taken as a lump sum only gets accounted for if it pushes an individual’s total capital beyond the £10,000 threshold. Beyond this point the amount you receive will fall as an income of £1 per £500 (or part thereof) above the minimum is assumed. Eventually your entitlement would cease as the assumed income would meet the government set minimum amount.

If you take an income, the amount of pension credit you receive will also fall to reflect this.
Council Tax Benefit (CTB) – the amount you receive depends on either the amount of capital you have or the level of income you receive (or both).

If you take your equity as a lump sum and it pushes the amount of capital you own to over £16,000 then your entitlement to CTB would stop (unless you receive Guaranteed Pension Credit in which case you still receive full entitlement).

If, on the other hand, you draw the amount as a regular income, the amount of CTB you receive may be reduced (the level of which depends on the income received).
Free healthcare benefits – if you are over the pension age and do not meet certain income or capital thresholds, you are probably entitled to help with costs such as dental treatment and visual aids; these may or may not be withdrawn.
If you are below the state pension age and you release equity from your property, it may also impact your eligibility for things such as Council Tax Benefit and various healthcare benefits.

In addition, should you be on Income-Based Jobseeker’s Allowance, Income Support, or Income-Based Employment and Support Allowance, releasing equity can impact how much you receive or if you do at all.

You should always ensure that you release equity in the way that leaves you best off overall. Take too much in a lump sum and your income may fall considerably due to the loss of key benefits. On the other hand, you may find that any equity released as an income is partly offset by the reduction of benefits.

Can I Repay The Loan Early?

You should think of equity release as a long term plan which is only completed upon your death. While it is possible to repay a lifetime mortgage early, you could find that the redemption charges are quite severe.

If you took out a home reversion plan, the only way to get out of it is to sell the property. Given the large steaks often taken by the company, you will probably find it difficult to buy another property with the slice you are left with.

Can I Release Equity In A Property Abroad?

While the vast majority of companies will only allow you to release the equity in a UK property, there are a small, but growing, number of companies that deal specifically with overseas properties.

We cannot recommend any specific companies and we strongly advise you to look in great detail at any that you might come across. Do your due diligence before entering into any agreement.

What If I Have Bad Credit?

Because you have an asset in the form of property, getting a lifetime mortgage should not be an issue even with a poor credit rating. Unlike unsecured loans and credit cards, the lender has the safety in knowing that whatever happens, there is equity built up in your home to repay the debt.

And if you opt for a home reversion plan, it is not a form of credit per se, so your personal financial circumstances will not come into play.

How Is My Property Valued?

To calculate the amount of money that can be released from your home, the company must get a valuation from a chartered surveyor. This valuation must be independent so as to be fair to both parties.

If you believe that the valuation being proposed is too low, you can try and get a second opinion from your own independent surveyor, or you can pull out of the deal altogether.

Can I Move House?

With a lifetime mortgage product, assuming you have ensured that the contract contains mention of portability, you should be able to move home and keep the same deal.

If you opt for a home reversion plan, you will only be able to move house if you still hold a sufficient share in the property to finance a purchase – this is unlikely to be a realistic choice for many.

What If The Property Is In Joint Ownership?

If you own your home with a partner, the rules are fairly straightforward. First of all, you both need to meet the age requirements set out above (55 or over for a lifetime mortgage and 65 or over for home reversion) in order to qualify.

Next, if both of your names are on the contract, then if one of you dies, the other can remain living in the property until they also die or go into care.

What Is A Lifetime Drawdown Mortgage?

A drawdown mortgage sits somewhere between taking a lump sum and arranging an ongoing monthly income. Essentially the lender provides a cash reserve facility which means that you can withdraw smaller cash sums as and when you need them.

The biggest benefit is that you only pay the interest on the money that has been withdrawn and not on the total amount available to you so you face less compounding over time. There are downsides in that this facility may only last a fixed number of years or it may be withdrawn if the lender chooses to do so.

Do I Need To Give Power Of Attorney To Someone?

While it is rarely a condition that the person releasing equity has power of attorney arranged, it can be a good idea to do so. If you have an accident or fall ill and are unable to handle your own affairs then having a child or friend to deal with the arrangements is a sensible precaution to take.

If you have a lifetime mortgage, but did not take the full amount that was possible at the time, this person could then decide to release further equity in order to help pay for your care or other needs you might have.

Can I Release Equity From A Leasehold Property?

Most providers will accept leasehold properties for equity release, although the length of the lease will play a role. Generally, you should have a minimum of 30 years left on the lease from the date at which the arrangement ends – i.e. when you die.

So if they expect you to live for another 25 years, the lease might have to be 55 years or more for you to be able to go ahead with the deal. Depending on the cost, you can always extend the lease to a sufficient length beforehand.

What About Properties Of Non Standard Construction?

If you own a home that is not a standard brick or stone frame, or is a timber one built before 1950, you will find it much more difficult to find a suitable scheme.

Similarly, mobile homes and park homes are unlikely to be eligible and nor are Grade 1 listed properties (lower grades might be ok).

If you are unsure what type of construction your property is, look at the deeds and solicitor files from when you purchased the property. If you bought the property using a mortgage, you should also be able to find details on your mortgage documents.

Can The Money Be Used To Fund Care?

If you are looking to pay for care within your own home, equity release is certainly an option.

If, on the other hand, you need to fund care in a residential home, it is not a possibility. Instead, you will simply have to sell the property to fund your care.

What Are The Alternatives To Equity Release?

If you don’t want to opt for an equity release product as outline above, there are some other options available to you. These can allow you to get just as much of a lump sum (or even more), but there are other implications and considerations to make.

Remortgaging

Whether or not you have already paid off one mortgage on your property, you may be able to remortgage to effectively take some money out of your home to use how you like. Essentially, you will once again have to make monthly repayments and pay interest just like any other mortgage holder.

The chances of you securing a remortgage lessen as you get older. If you are 55 then you could be permitted one of quite some length, particularly if you still work. Remortgaging becomes less of an option for those over the age of 65 unless you can prove a significant income from other sources – although in which case you might be better off liquidising them instead.

Downsizing

By moving from your current home into something less valuable, you can pocket the difference in sale and purchase prices. The amount you get is only dependent on the disparity in value between the two properties.

While you do not have to pay a provider any interest or sell a proportion of your home at below market rate, there are other costs involved including stamp duty, estate agent fees, solicitor’s fees and those involved with actually moving.

The main downside is obviously leaving a place that you may have called home for a considerable length of time.

A benefit is that you can move into a property that is more suitable for your needs; this may be something on a single story or somewhere with fewer rooms to heat, clean and maintain.

Downsizing is not always a quick way to release equity though. Depending on the state of the market and the demand for properties like yours, it could take months or even longer for any sale to go through and there can be lots of stress involved if you find yourself in a chain.

Choosing The Right Option

With the array of options available to you, we highly recommend that you take your time making the final decision. Always seek independent advice, even if a deal seems like a good one on first impressions, and don’t be afraid to ask any and all questions that you might have during the process.