The UK equity release market is worth billions of pounds a year and still growing. Historically, there have been issues with regards to interest rates, small print and varying degrees of transparency.
Thankfully, in recent years the authorities have stepped in to introduce an array of regulations which have given consumers more confidence about the options available and the various products on offer.
In this article, we are focusing on equity release schemes as opposed to remortgaging for equity release. However, we will cover remortgaging for equity release before we move on.
Remortgaging to Release Equity
There are three main scenarios where you may refinance your existing mortgage to release equity in your property.
Increase in Property Value
Let us assume that you have an interest-only mortgage; thereby, the principal capital will remain constant. Your mortgage payments will be interest-only with the capital repaid at the end of the term.
Now let’s assume that the value of your property increased from £100,000 up to £300,000 – quite conceivable if you bought a property in the 1980s/1990s.
If we work on an LTV ratio of 70% here are some theoretical figures:-
|Valuation Date||Property valuation||LTV Ratio||Maximum mortgage||Remaining equity|
|Valuation on purchase||£100,000||70%||£70,000||£30,000|
|Valuation June 2020||£300,000||70%||£210,000||£90,000|
So, using the above figures, it would be possible to remortgage your property in June 2020 on the same LTV ratio as your original mortgage and raise £210,000.
You would use £70,000 from this payment to repay the original mortgage, thereby releasing equity of £140,000 and still have £90,000 in equity remaining in your property.
Mortgage Paid Down
While it is still possible to negotiate interest-only mortgages, the vast majority of homeowners are likely to be on repayment mortgages. This means that each monthly mortgage payment is split between paying down part of the capital and paying the interest on the outstanding loan capital.
So, let’s assume that you are 15 years through a 20-year mortgage there is every chance you will have built up significant equity in your property – even before any increase in the value of your home.
Therefore, depending upon your circumstances, you may be able to remortgage your home and release a large amount of equity.
Research shows that homeowners are quite happy to fund home improvements, whether economies are buoyant or in recession. It seems that many consider the cost of home improvements as a long-term investment and therefore, worthwhile.
However, there are scenarios where it may be possible to release equity in the short-term due to an increase in the value of a property, as a consequence of the improvements.
The following table gives you an idea:-
|Valuation Date||Property cost/Value||LTV Ratio||Max Mortgage/development loan||Equity|
|Property revaluation (post improvements)||£160,000||70%||£112,000||£48,000|
In this scenario, you can see that the mortgage and the development loan amounted to outstanding debts of £100,000. The property was worth £100,000 before the improvements, but they increased the value of the property up to £160,000.
Using the same LTV ratio as the original mortgage, on the improved value of the property, this equates to a maximum mortgage of £112,000. You would use £100,000 of this to pay off the original mortgage (£70,000) and the development loan (£30,000) thereby releasing equity of £12,000.
In this scenario, the remaining equity in the property would also have increased from £30,000 up to £48,000.
We will now move on to equity release schemes which are a very different ways to release equity.
How Do Equity Release Schemes Work?
Equity release schemes basically allow you to borrow/raise funds against the equity in your property with what is known as lifetime mortgages or home reversions.
Although not set in stone, the minimum age for a lifetime mortgage is usually 55 although this can rise to 60 for home reversion schemes. While there is some controversy about raising equity in this manner, for many people, it offers them the chance to address other issues in their life.
As we mentioned in the introduction, in years gone by the equity release sector suffered from a terrible stigma due to the actions of a minority of companies.
Thankfully, things have changed dramatically in recent times; the industry is more heavily regulated and has never been more transparent.
Reasons for Equity Release
The potential uses of equity release are endless, but some of the more common reasons for raising capital include:-
Pay Off an Existing Mortgage
Unfortunately, some mortgage companies are not very forthcoming regarding remortgaging for those over 50. As a consequence, some homeowners may look to release equity in their home to pay off an existing mortgage.
This not only takes away that particular debt but would also immediately improve their short-term cash flow.
Fund Home Improvements
Releasing equity to fund home improvements tends to be carried out via basic equity release (see above) or lifetime mortgages. The fact these home improvements should be increasing the value of the property, hopefully, beyond the cost of the improvements is something to bear in mind.
In effect, this is a long-term investment funded by a lump sum equity release.
Boost Disposable Income
For many people approaching retirement and beyond, they can see a significant reduction in their disposable income.
Very often, this can restrict their hopes and activities for the future even though they are living in a property in which they have significant equity.
So, many people will choose a form of equity release to boost their disposable income with some schemes offering lump-sum payments or regular payments.
Inheritance Tax Planning
If you’re looking to raise capital to address inheritance tax or any other tax issues, it is very important that you take professional financial advice.
You may think that you are removing a potential tax liability for your family in later years, but sometimes this may not be the case.
Take advice and act on the advice.
Imagine the scenario, you have been in employment for more than 40 years, and you have decided to take retirement. Unfortunately, even though you may have enough to fund the comfortable lifestyle you wanted, your funds may not stretch to that dream holiday, maybe a cruise around the world.
So, it is no surprise to learn this is a popular reason for considering equity release schemes.
You may be buying a vehicle, purchasing a boat or motorhome, and due to your age, you may struggle to secure more traditional loans.
Those who acquired their homes before or during the 1980s may have seen a huge increase in the value of their property.
So, again it will be no surprise to see many homeowners releasing equity to fund that dream purchase.
When you compare and contrast traditional mortgage rates to those offered by lifetime mortgage schemes (equity release), you will see that traditional mortgages tend to be lower.
As a consequence, there are very different opinions regarding the use of equity release schemes to raise funds to acquire a buy to let property. This is another area where you would be strongly advised to take professional financial advice.
This covers the main reasons why homeowners tend to utilise equity release schemes, although this is by no means an exclusive list.
Different Types of Equity Release Schemes
We will now take a look at the two main types of equity release schemes which are growing in popularity, especially amongst mature homeowners.
As the name suggests, a lifetime mortgage is a type of mortgage, although there are some marked differences when compared to traditional mortgages. Before we take a look at lifetime mortgages in detail, it is worthwhile noting the process from start to finish.
Lifetime mortgages normally apply to properties where the original mortgage has been paid off, or there is a relatively small amount outstanding.
The first thing to do is value your property so that you know the equity content.
Approach Lifetime Mortgage Provider
While many people tend to go through mortgage brokers, you can approach a lifetime mortgage provider directly for more information.
They will discuss your particular scenario in more detail, confirm the potential funding available with rates and any additional fees.
Agree on Mortgage
Assuming that you were able to agree a lifetime mortgage, you would normally receive a lump sum (although there are other options).
The more common approach is to rollup interest accrued via the lifetime mortgage, so there are no payments.
Under a lifetime mortgage, you will retain ownership of your home although the mortgage company would hold a charge over the property until repaid in full.
You will also live in the property rent-free, as you would if you had taken out a “traditional mortgage”.
Repayment of Mortgage
Repayment of the lifetime mortgage would occur when either you moved into long-term care or when you die, and the property is sold. Any excess funds raised would be returned to the mortgagee or their estate.
There are also numerous other issues to consider before going down this route.
For many people, the main attraction of a lifetime mortgage revolves around the fact that you don’t need to make any payments to the loan. In the majority of cases, the capital (and interest) would be repaid when you die, or move into long-term care, with the interest rolled up from day one.
As you can imagine, there is the potential for significant rolled-up interest at the end of the mortgage because effectively you will be paying interest on interest.
The interest could be added monthly or annually – depending upon the agreement. However, there are some alternatives:-
You can opt to make interest payments on a monthly basis, thereby reducing your end repayment to the original capital. This will obviously depend upon whether you are in a position to cover interest payments and your cost of living.
There is an argument to suggest that if you are able to make interest payments, then a lifetime mortgage may not be for you. On the whole, the interest rate on lifetime mortgages is higher than those negotiated for traditional mortgages.
It may also be possible to arrange capital repayments on a regular or a one-off basis which will reduce interest charges going forward.
When you bear in mind that the traditional method of rolling up interest, with the mortgagee, charged interest on interest if you’re able to pay off capital going forward this can make a huge difference to the total cost.
It is also worth noting that some agreements will include potentially sizeable charges should you choose to repay the capital early.
Equity Release Drawdown plan
For those who want to raise money on their property, and are maybe not in a position to make any repayments, lifetime mortgages are certainly worth considering.
As we highlighted above, one of the downsides is the fact that interest is rolled up for the duration of the mortgage. However, there is the option of a drawdown plan.
This effectively puts aside an interest-free pot of money for you to drawdown as and when required – you will only be charged interest on drawn funds. A useful addition to the options!
While some might suggest that lifetime mortgage companies tend to focus on the option to rollup interest, in reality, this is the preferred natural option of many people.
The whole point of lifetime mortgages is to extract capital which is required in the short-term for a variety of reasons.
Other Lifetime Mortgage Factors to Consider
While we have covered an array of factors to consider when looking at lifetime mortgages, here are some useful bullet points:-
- The normal LTV ratio for lifetime mortgages will be a maximum of 60% – the older you are, the higher the maximum LTV ratio.
- Most lifetime mortgage interest rates will be fixed, and even variable interest rates must have an upper “cap” fixed for the duration of the mortgage.
- You also have the right to move property, but this must be cleared with the lifetime mortgage provider and appropriate security put in place.
- There is a “no negative equity guarantee” which means that any shortfall after your property is sold, to repay the mortgage, is written off.
There is no doubt that lifetime mortgages certainly have a role to play, especially for those with mortgage-free properties in their later years.
Obviously, the issue of rolled-up interest is one which needs to be considered in great detail because it can have a significant impact on long-term liabilities.
However, there is always the option to pay off the interest on a monthly basis, thereby just leaving the original loan capital to be repaid.
There are few equity release options which have caused as much controversy as home reversion schemes. It is a little unfortunate because the industry we see today is very different from that of 20 or 30 years ago.
Regulations are now much tighter, agreements are now more transparent, and nothing is hidden. However, there are still a number of issues to take into consideration!
Before we go any further, it is probably sensible to look at the process of applying for home reversion funding which is relatively straightforward:-
The first thing to do is value your property so that you know roughly the figures you are working with when you approach a home reversion provider.
Decide on the Level of Equity Release
Once you know the value of your property, assuming there is no mortgage, it is then time to decide on the level of capital you require.
While it would obviously need to be worthwhile for the home reversion company, depending on the value of the property, you could sell off as little as 10%.
Approach Home Reversion Company
After taking financial advice, it is time to approach the home reversion company to discuss their terms and conditions and try to arrange funding. If successful, the home reversion company will buy a percentage of your property, but unfortunately, this will be anywhere between 20% and 60% of the market value.
The concept of raising funds via a home reversion scheme may sound interesting in theory.
When you dig a little deeper and realise that the lender may pay as little as 20% of the market value for a share in your property, this may make you think again.
Factors to Consider
There are a number of reasons why home reversion companies will only pay a fraction of the market value of your property on a pro-rata basis.
This is because:-
- It could be decades before the home reversion company are repaid in full
- There is no guarantee of future house price movements
- You will make no repayments for the duration of the arrangement
- You will live rent-free in the property until you die or move into long-term care
- There is an option to stagger withdrawals in the future
- You can move property if continued security is provided
- There is a “no negative equity guarantee” – you will never be chased for any shortfall
In effect, the home reversion company is quite literally buying a stake in your property. Therefore, if the value of your property increases, then the value of the home reversion company’s stake will also increase.
Let us assume for example the home reversion company acquired a 20% stake in a property valued at £200,000, but they only paid £20,000 (a discount of 50%/£20,000 to the market value).
|Date||Property Value||Homeowner stake value||Home Reversion company stake value|
As you can see, the market value of the home reversion company’s stake in your property increased from £40,000 up to £100,000. However, they paid a discount to the market value and effectively bought a £40,000 stake for just £20,000. Not a bad return!
Obviously, there is no guarantee where house prices will move in the short, medium and long-term and therefore home reversion companies are taking a degree of risk – this is reflected by the discount to market value purchase price.
Interestingly, from signing the home reversion agreement, the homeowner will have the option to buy out the home reversion company. However, they would need to pay the full market price even though the home reversion company bought the stake at a discount of 50% (in our example) to the market value.
I think we can assume that very few homeowners would look at this option?
When looking at lifetime mortgages or home reversion schemes, it is very important to take financial advice prior to signing any agreements. These important decisions should be considered in the context of your overall finances, plans for the future and the potential risks/rewards.
While equity release schemes have had their critics in years gone by they do offer a very useful means of raising capital for those in later years.
In many cases, their age may exclude them from the traditional mortgage/remortgage market, as well as their income in later life.
Over the years, we have seen a huge increase in the level of funds raised via equity release schemes such as lifetime mortgages and home reversion schemes. As people grow older, want to do things in later life and have little income but significant equity in their property, equity release can make perfect sense.
While these two schemes obviously have their drawbacks, rolled up interest and purchase of a property share at less than market value, there is a degree of risk taken on by the lenders.
When looking at lifetime mortgages, it is worth considering the fact that UK base rates are currently at a historic low. So, even though the mortgage rate for lifetime mortgages tends to be higher than that for traditional mortgages, it is currently relatively low.
If possible, those able to pay interest on a lifetime mortgage would reduce/eliminate additional rolled-up interest charges. However, for many, the main reason they would even consider equity release is to raise much-needed funds.
How Can Equity Tree Help?
Here at Equity Tree, we have partnered with some of the UK’s leading Equity Release broker companies.
They have already helped thousands of people release equity already, and they can do the same for you.
Choosing an independent adviser means they won’t recommend a scheme unless they are sure it is in your best interests. Their advice is also regulated by the FCA, which gives you an additional layer of protection.
If you would like to speak to one of these equity release companies, click on the below and answer the questions.