Equity Release Mortgages

Equity release schemes offer property owners the opportunity to raise cash from the value of their homes, whilst still allowing them to remain living in the property.

Numerous schemes exist with various different options. Because the details can be complicated and a certain amount of risk may be involved, anybody considering equity release should take independent legal and financial advice before proceeding.

As a result of the current pensions situation in the UK, many retired people find themselves living in a property worth several hundred thousand pounds, but not having enough cash to live on. Although there are other reasons for considering equity release, (e.g. funding home improvements or reducing inheritance tax liabilities), releasing cash from a property as a source of income is tempting for an increasing number of people.

Potential Equity Release Pitfalls

When Which Magazine investigated equity release schemes, its findings did not make pleasant reading. Its conclusions were that many equity release schemes were expensive, inflexible and risky. Although, financial institutions disputed Which's findings, it was clear that in many cases interest rates charged for equity release mortgages compared unfavourably with conventional mortgages. Similar observations have also been made by the Financial Services Authority (FSA).

Types of Equity Release Mortgage

Equity release schemes can be divided into four broad categories:

Home income plan: property is mortgaged and the cash raised is used to purchase an annuity;
Interest only mortgage: property is mortgaged and the owner takes cash sum and makes interest payments, with capital being repaid at a future date;
Lifetime mortgage: property is mortgaged and interest is added to the balance owing, which is paid off when the owner dies and the property is sold;
Home reversion scheme: property (or share of a property) is sold to a financial institution in exchange for a lump sum or monthly income.

The individual property owner's circumstances should dictate the choice of equity release scheme. However, equity release schemes are not appropriate for all homeowners.

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Home Income Equity Release

With a home income plan, the property owner mortgages their home and uses the cash raised to purchase an annuity to provide an income for life. Mortgage interest payments are deducted from the income, but the capital sum is not usually repaid to the mortgage provider until the property has been sold, after the death of the property owner.

Advantages of Equity Release Schemes

The property owner is guaranteed a monthly income for life, with mortgage interest payments being made from this monthly income;
The mortgage sum owing is constant so that any increase in value of the property benefits the property owner or their heirs.

Disadvantages of Equity Release Schemes

The income generated is fixed and its real value will be reduced over time by the effects of inflation.
Rates for annuities incorporated into home income plans are not usually very competitive; other schemes giving more investment flexibility offer potentially better returns.
Equity release is not generally the best method to raise a cash lump sum.

Because annuity rates have fallen significantly, in recent years, the previous popularity of home income plans and other schemes involving annuities has diminished considerably.

Interest Only

The property owner takes out a mortgage on their home to raise a cash sum, which can be spent as desired and makes monthly repayments of mortgage interest. The capital sum borrowed is repaid to the mortgage provider when the property is sold at a future date.

Advantages of Interest Only

The mortgage balance owed is constant, so that any increase in the value of the property benefits the property owner or their heirs.
If a property owner chooses a fixed rate mortgage deal, the exact cost of their mortgage repayments will be known, which facilitates easier budgeting.

Disadvantages of Interest Only

A property owner needs to ensure that mortgage repayments can be covered comfortably from income, so investment decisions regarding the capital sum released should be considered carefully.
Because annuity rates are low at present, they do not generate adequate returns for most people, so alternative investments should be contemplated.
If a property owner chooses a variable rate mortgage deal, they risk a cut in net income if interest rates rise.

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Lifetime Mortgage Equity Release

With a lifetime mortgage, a property owner takes out a mortgage on their home. The mortgage provider will pay a lump sum or a monthly income (or a combination of the two). Throughout the mortgage term, the lender will continue to add the interest owed to the capital sum borrowed. After the death of the owner, the property will be sold and the mortgage provider will reclaim what is owed to them (capital and interest) from the proceeds of the sale.

The amount that can be borrowed depends on the age of the borrower and on the value of the property. As a general rule, the older the borrower is, the larger the amount that a mortgage provider will advance, although they are unlikely to lend more than 50 percent of the value of the property under most circumstances.

Advantages of Lifetime Mortgages

The property owner will receive a larger income from a lifetime mortgage than from a home income plan or an interest only mortgage.
If a property owner chooses a fixed rate mortgage deal, they will be able to estimate their total liabilities more accurately and budget accordingly.
Lifetime mortgages are available to people from the age of 55 onwards.

Disadvantages of Lifetime Mortgages

The property owner's heirs will not know how much equity is left in the property until it is sold and the mortgage is finally redeemed.
As total interest owing continues to accumulate, especially if interest rates are high, the property owner's heirs could be left with little or nothing, even if the mortgage was for a relatively small proportion of the property's value when it was taken out.
Unlike other types of equity release schemes, a property owner with a lifetime mortgage would be unlikely to have the option of obtaining a further loan in the future.

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Home Reversion Equity Release Mortgages

Using a home reversion scheme, the property owner sells their home (or a share of the home) to a financial institution. The firm will pay a lump sum or a monthly income (or a combination of the two). In effect, the property owner becomes a tenant of the financial institution at zero rent or at a very low rent until they die.

When the property is eventually sold, the financial institution takes its share of the proceeds. For example, if it had bought a 40 percent share in the property, it would receive 40 percent of the sale receipts. Because the original property owner will continue to live in the property, possibly for many years, the financial institution will not pay the current market value for the share of the house that it is buying. If you were to sell the whole of your property to a financial institution under a home reversion scheme, you could expect to receive between 30 and 60 percent of the market value. The actual percentage will depend on how long the financial institution's actuaries expect you to live; it will depend on your age, sex, smoking habits and state of health.

Advantages of Home Reversion Mortgages

The original property owner will know the percentage of the property (but not the value) that they will be able to bequeath to their heirs.
If the whole property was not sold by the original property owner, monetary value will continue to accrue to them from any increases in the price of the property.
If the owner has equity remaining in the property, further shares can be sold at a later date.
The original property owner will not have to make any repayments during their lifetime.

Disadvantages of Home Reversion Mortgages

A financial institution will insist on purchasing a property at considerably below its market value.
Financial institutions are sometimes fussy about the properties they will purchase because they need to be good long-term investments in order to be viable.
If a property owner dies soon after selling all or part of their home, they could have lost a large sum of money with little benefit to themselves; some financial institutions will offer rebates to families if the property owner dies within the first few years of a home reversion scheme.

Your home may be repossessed if you do not keep up repayments on your mortgage

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