Equity Release

For many homeowners, one of the comforting things about the recent boom in house prices is that the available equity can be used to finance other aspects of life. For some, this might mean using some of it for buy-to-let purposes, for home improvements or even, unwise though it is, to consolidate other debts.

For the retired, it can mean the difference between living in penury and enjoying the lifestyle one would hope for on retirement. The easiest way to do this is to sell up and move to a smaller house using the difference in some way to provide extra income. As retired homeowners are now estimated to be sitting on property worth almost £1,000 billion, it is a plan that they may want to consider!

However, many retired people don't want to move and the only way they can get cash from their home is to use an equity release scheme. This is effectively a form of 'lifetime mortgage' which doesn't have to be paid back until you die or move into long-term care.

However, equity release schemes are often expensive. Although they have been getting slightly cheaper recently as more and more companies start to offer them, it is still quite an immature market, with only around 100,000 equity release mortgages currently in existence. Most commentators reckon that equity release schemes are too inflexible and complicated (they can affect the level of means-tested benefits you receive for instance) and that they are best thought of as a last resort.

To make matters worse, the quality of advice given about equity release schemes has also been questioned. A mystery shopping exercise carried out by the FSA in 2005 highlighted many shortcomings such as not enough information being gathered from customers and inappropriate recommendations on where to invest funds freed up by equity release schemes.

Although there are variations, there are two main types of equity release scheme:

1. Interest Roll-up Loans

Otherwise known as Cash Release Plans or Lifetime Mortgages, essentially you borrow money against the value of your home usually in return for a lump sum although some schemes offer the option of being able to take the money in the form of a monthly income for the rest of your life. You don't pay anything back while you're living in your home; instead the interest is added to the loan and the whole amount is only repaid once the house is sold.

The amount you owe can grow very quickly because you're charged interest on the interest that is added to the loan each year, as well as on the original amount borrowed. And as it's not unusual for interest rates on equity release mortgages to be higher than ordinary mortgages then, depending on how much you borrow and how long you have the loan, it could eat up the bulk of the value of your home.

If you want to move elsewhere, an interest roll-up loan may have used up so much of the equity in your present home that you can't afford to buy something else. Early repayment may also result in redemption penalties. However, the one good thing is that most lenders offer a 'no-negative equity guarantee' that means you would never owe more than your home is worth.

2. Home Reversion Plans

With a home reversion scheme, you sell all or a percentage of your home to a company for a fixed sum or a monthly income (or both) although you retain the right to live there for the rest of your life. If you decide you want an income, you usually have to buy an annuity from the reversion company so you have to bear in mind that if you pop your clogs soon after, then you won't get the full value of the plan.

The problem with this sort of scheme is that you won't get anything like the full market value -- perhaps just 40% to 60% of what your home is currently worth. And the younger you are, or the better your health or if there's a spouse or partner involved, the less you'll get.

The company also benefits from any increase in the value of the part of your home that you sold, and you -- or your estate -- only benefit from whatever part you keep.

Note that Home Reversion Plans currently aren't regulated by the FSA, unlike the rest of the equity release market. However, it was recently announced that would soon will be, most likely from Spring 2007.

Useful links: Equity Release discussion board | Age Concern factsheet