Equity Release – Explained
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Equity Release Explained
Kevin Spear from Mortgage Marketplace joins us to explain equity release.
What is equity release and how does it work?
Equity release is a bit of a generic phrase. It is also known as a Lifetime Mortgage, or referred to as Later Life Lending.
These products are for people aged 55 onwards, where there’s a mortgage requirement into old age and post retirement. A lifetime mortgage might be needed when there’s not a lot of income floating around. There are all sorts of solutions for people that still need a mortgage or to borrow money when they retire.
Is equity release a good idea? How do I know if it’s right for me?
Equity release can form quite a significant part of someone’s financial planning in later life. It can be a very good idea for a variety of different reasons, depending on the individual’s circumstances.
As to whether it’s right for you, that really is down to a discussion with a competent mortgage broker who’s qualified in the equity release / lifetime mortgage space. It is a separate licence that we study for, because the advice around these products is more complex than your regular residential mortgage.
So talk to a broker and see whether it’s right for you. When used correctly, it can be a very effective piece of financial planning.
What are the common uses of equity release?
There are a number: including inheritance tax planning, where someone may wish to create a debt on their estate to reduce an inheritance tax bill. At the other end of the scale, they can be used to repay an existing residential mortgage – often an interest-only mortgage than is now due.
The mortgage might be tied to an endowment, an ISA or a pension, but that repayment vehicle has ceased to be, has lapsed or the client has stopped paying into it.
People also often use an equity release mortgage to create a gift to help children to buy property, for grandchildren, to pay school fees – all sorts of things.
Or, quite simply, it might be that the client is ‘asset rich, cash poor’. They might only have a state pension or a small occupational pension, but there is lots of equity in their property that they would like to access.
It ultimately becomes a lifestyle choice of whether to take a lifetime mortgage to borrow money and have a more comfortable later life.
What criteria is looked at for equity release?
It’s only two things. It’s the value of the property and the age of the applicant. The younger the applicant, the less money is available as a proportion of the property value. The older the applicants, the more money is available against the value of the property.
People can borrow more money as they get older, so it’s not just one bite of the cherry. Again, it depends on the individual’s needs. Some people have a need now, and they may have another need in the future.
As we all get older, of course, no one necessarily knows what their health is going to look like in later life. So that ability to take money later after an initial loan amount can be very helpful.
What is the downside of equity release?
The downside is that the mortgage is a debt – there’s no escaping that issue. The debt can be managed in a number of different ways. It can be an interest-only type of mortgage, where the applicant only makes a payment to cover the monthly interest per month.
In that sense, the debt stays the same. It doesn’t get any bigger. If you borrow £100,000 on day one, at the end of the mortgage, you still owe £100,000.
On the other end of the scale is a ‘roll up’ account. Here, the interest is accruing every day and added to the loan, so the loan is getting bigger. Interest is compounded over the years that the client has the mortgage. In that scenario, there is quite significant erosion of equity in the property.
When we have people take that option – and many do – we make them aware of the rate at which that loan will grow. We will often involve family members in that discussion to explore whether this is the right thing to do. That way, everybody in the family is aware that this debt exists on the property.
There’s also a halfway house option – people can pay the interest, or part of it, for a period of time. It can be an ad-hoc arrangement to reduce the erosion of equity.
What are the positives of lifetime mortgages?
The flip side of that negative is what the money enables the client to actually do. As we mentioned previously, it can suit a very varied set of circumstances.
Equity release can be life changing in many respects – it gives you the option to do things that otherwise wouldn’t happen because the money is not there.
What about beneficiaries’ concerns about their inheritance?
Lifetime mortgages are a debt. That debt accrues interest, and the interest grows. But the interest on a lifetime mortgage is fixed for the entire contract. So we can give clear figures to beneficiaries. We can explain that in year 10, if your parents pay no interest, the debt will be X and in year 20 it will be Y.
We go to quite considerable lengths during the advice and application process to counsel the client around making their family aware of what they are doing. It’s quite a delicate balance, because obviously people’s financial planning is private – they might not want to share that information. Meanwhile others will readily do it.
Myth 1: ‘Equity release isn’t regulated.’
Equity release is regulated, as are the advisors and the product providers. There is significant legislation ensuring that communication is transparent, that people understand the contract they’re getting into and that it’s appropriate for them.
There’s always a solicitor involved in the transaction to do the legal work for the lender, but that solicitor must also make sure separately to the advisor and lender that the client understands the terms of the arrangement.
So there are a couple of safeguards in the process there, plus the transaction itself is regulated. The Equity Release Council is the governing body for lenders and advisors, and it sets out a Code of Conduct and a set of standards.
Certainly for the last 10 years or so, the equity release providers have really upped their game to make sure that what they’re providing for clients is suitable, fair, priced effectively and offers a good financial solution.
Myth 2: ‘It’s called a lifetime mortgage, so I have to stay in my property for the rest of my life.’
Lifetime mortgage is the correct term for what most people refer to as equity release. But it doesn’t mean that you need to stay in the property for your lifetime. All lifetime mortgage products are portable – they can be transferred to another property should you wish to move home.
A lot of people do move home, especially to downsize. In some cases, we use the downsize transaction as an opportunity to repay a lifetime mortgage if that’s appropriate. So there is quite a lot of flexibility around the way in which a lifetime mortgage can be used, repaid or transferred to another property. Don’t get hung up on the term ‘lifetime’. It’s not for life, but it can be if needed.
Myth 3: ‘With a lifetime mortgage you can end up owing more than your house is worth, leaving children and family with debt.’
That’s a common misconception. A couple of things are put in place to ensure that the debt never increases above the value of the property. The first is the initial amount borrowed by the client. It’s set at a level that provides plenty of headroom even with interest rolling up on a daily basis. The initial amount is quite small compared to your standard residential or Buy to Let mortgage.
The second thing is that the products themselves hold a No Negative Equity guarantee. In the unlikely event that the debt goes higher than the value of the property, which would require quite a significant property crash, the debt can never exceed the value of the property.
Therefore there cannot be any negative equity and there’s no liability on the estate of the applicant.
Myth 4: ‘Equity release rates are really expensive.’
No. Equity release rates are at market rate. If the market is low, equity release rates are low. If the market is going up, equity release rates go up.
We’re recording this in spring 2023 and in quarter four of 2022, we had an unprecedented set of interest rate rises across the market because the Bank of England base rate went up. All interest rates and mortgages were affected by that – equity release amongst them, but not in a disproportionate way.
Equally, as those rates come down, equity release rates will follow.
Myth five: ‘I’ll lose control and ownership of my home.’
Again, this is a common misconception. The ownership of the property remains with the applicant. It’s just like any other mortgage. When you buy your home with a residential mortgage from one of the high street lenders, the house is yours.
It’s exactly the same when we put a lifetime mortgage on a property. The house belongs to the applicant. It just has a mortgage on it.
Myth six: ‘I haven’t completely paid off my existing mortgage, so I can’t look at equity release.’
Again, this is completely untrue. Around half of the equity release cases we do for clients are, in fact, to repay residential mortgages at the end of their interest free term.
People worry when letters start coming through from the residential lender, because they’ve now got to repay this mortgage to stay in their home. And often the endowment, ISA or pension repayment vehicle that was originally there, now isn’t in place. Equity release can be a very significant, pragmatic way of repaying that residential mortgage.
How can a mortgage broker help if somebody is looking into equity release?
In the equity release space, it really is a question of getting the appropriate product and loan size for the client’s situation. When we undertake mortgage advice for somebody buying a home or a Buy to Let, they tend to know what they want so we explore what’s out there in the marketplace.
With lifetime mortgages, it’s completely different because it is based on advice. Clients come to us not really knowing what the solution is. They’re looking for support with that decision, and transparency about the product that they’re getting into.
We are very aware of the vulnerability of the client, and we ensure that the family is involved if clients wish that to be the case. We make sure everything is clear, understood, and appropriate.
It’s a big decision going down the lifetime mortgage route – as big as a first mortgage – and it also has implications for beneficiaries. So we are at pains to take things at the client’s pace and make sure they understand it.
A lot of people are reaching the end of their interest free mortgage without a repayment vehicle in place. Endowment policies were set up in the 90s but they didn’t represent good value for money. People were encouraged to stop paying them, and many did.
Here we are today and these mortgages are coming to an end. A lot of people are very scared of that brown envelope coming in from the lender asking for repayment. People think there isn’t a solution, or that they have to move home. We’re here to take that stress away. There is a solution out there for the vast majority of people. We will walk you through that process, take the stress away, make it doable, make it transparent.
So get a hold of a mortgage broker as early as you can. It needn’t be that scary and there are no silly questions or circumstances.
Frequently Asked Questions
Typically, the mortgage process will take 2-6 weeks to reach approval.
A mortgage offer is usually valid for 6 months.
Please be aware, the process is currently taking longer due to Covid-19. Please see question ‘How has Covid-19 affected the mortgage market?’.
Whilst you are not required to take out a life cover, our job is to ensure your mortgage is affordable, no matter what. It may not be nice to talk about, but if something were to happen to you, you want to know your family and investment are safe.
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