UK Edition
Equity release: how much can I borrow and what will it cost?
Equity release, which allows older homeowners to extract cash from the wealth locked up in their property, has grown in popularity dramatically in recent years.
Last year over-55s withdrew £3bn from their homes – a 40pc uplift on 2016 – meaning the amount of borrowing in the sector has trebled since 2012, when £926m was advanced.
As house prices have soared, the result has been more wealth available for homeowners to draw on. And with many pensioner households needing capital for a range of reasons, it's unsurprising that record numbers are using equity release.
The two key questions for anyone thinking of taking advantage of equity release are how much can I borrow and how much will it cost me?
How does equity release work?
Equity release schemes now almost all operate as "lifetime mortgages", although other forms do exist. There is no set term and payments to the lender, either of interest or return of capital, normally do not take place until the borrower dies or sells the home for another reason – to move into a care home, for example. The interest accumulates throughout.
Equity release interest rates are fixed for the life of the loan, giving some security to borrowers. It is also possible in some cases to “remortgage” the deals in future years, if rates and available deals make this viable. But because the interest is compounded the debt can mount significantly.
Other variants of equity release allow borrowers to withdraw money in stages rather than in one lump sum at the outset, which reduces the interest bill.
It is sometimes possible to make interest payments monthly, as with a normal mortgage. This arrangement, which is often used when a lump sum is given to children, who will usually be the ones who make the monthly repayments, also minimises the interest due.
Before undertaking equity release, homeowners should weigh up whether they could trade down to a smaller property.
Why do people do it?
The most common reason cited by borrowers is a need for money to repay what it left of a traditional mortgage. Equity release allows borrowers to swap the regular monthly payments required by a standard mortgage for the deferred repayments of an equity release plan, freeing up income to supplement pensions or for other purposes.
However, in 2017 the overwhelming majority of borrowers – 64pc according to Key Retirement, a major provider – withdrew cash to fund improvements to their home or garden.
A third of borrowers used the money to fund a lavish holiday, 24pc to help friends and family and a fifth to clear debts including mortgages and credit cards balances.
For older owners of valuable homes, inheritance tax planning is also a consideration. Individuals have an allowance of £325,000 before the tax is due at 40pc, but since April you have been able claim an extra £100,000 – rising to £175,000 by 2020 – against the value of your home if you are passing it on to a direct descendant. This will eventually allow a couple to pass on a £1m home tax free.
Equity release could be used to reduce the taxable value of an estate. When the person with the equity release plan dies, the mortgage is paid off from the value of the estate, with IHT then due on the remainder of the value. If, after the loan is paid off, the property is below the taxable value, no IHT would be due.
How much could I borrow?
Because most big providers of equity release promise borrowers that their debt will never be greater than the value of their house (the "no negative equity" guarantee), the amount you can borrow is strictly limited. The average borrower aged in their late sixties can typically release no more than 35pc of the property’s value.
A borrower aged 65 in a property worth £250,000 would be able to release a maximum of around £80,000.
Some major providers, including Aviva, have begun altering the maximum loan depending on your postcode, with areas more at risk of a house price correction deemed higher risk and more limited. This has been criticised for creating different deals between neighbours.
How much does it cost?
According to the Equity Release Council, the industry trade body, today's current average loan rate is 5.35pc, although some products will cost 6pc in interest while others can cost as little as 4.5pc.
While you borrow a fixed amount at a fixed rate, you won't know how long the loan will run for. But here are some worked examples of how the debt could mount.
Major lender Legal & General offers lower rates for those borrowing outside London and the south east, in a bid to rebalance its lending which is skewed towards this region. The rate on its Flexible Max Plus plan is 5.66pc for those away from London, and 5.72pc for those within the capital.
Will I have anything left to leave for my family?
This is the crucial question for many potential borrowers.
When you start your equity release deal you will know the rate at which your mortgage rolls up and the sum borrowed. What you won't know is the extent of future house price rises and how long you will live, which determines how much debt you accumulate.
The housing market appears to have stalled, so those who want to leave something for their family should think carefully before entering into an equity release deal.
If, however, house prices do recover, you are more likely to have assets to pass on.
For example, if you release £50,000 now from a home worth £250,000 and the loan runs for 15 years, you will build up a debt of £123,000. If we assume that house prices rise at 5pc a year, the value will be £528,000 in 15 years' time. So you will have £405,000 remaining to bequeath.
Reader Service: Interested in mortgages for the over-60s? Check if you are eligible for a lifetime mortgage with a free equity release calculator