Equity release - is it right for you?
Recent figures have revealed that many Britons have stopped paying into a pension due to the recession and it is only natural that many approaching retirement age are concerned about how they will manage financially.
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If you are likely to struggle on your pension alone and require an additional income, or simply wish you could take that dream holiday in your retirement, equity release could offer a solution.
There are two main types of equity release schemes - lifetime mortgages and home reversion plans.
Lifetime mortgages
A lifetime mortgage (sometimes called a roll up mortgage) effectively allows you to borrow against the value of your home. This is a long term commitment which provides you with either a lump sum or a regular income (depending on the plan) based on the value of your property.
For example, if you are 60 or over and have no mortgage on your property, you may be able to borrow 25 per cent of the property's value, though this figure increases as you grow older.
Interest is charged but is not repaid until the property is sold, at which point the loan is paid off.
Advantages
Both lifetime mortgages and home reversion plans allows you to stay in your home until you die or choose to move into residential care.
Lifetime mortgages have the advantage of being more flexible and there are many more providers which helps to maintain a competitive market. You only pay interest on the duration of the loan and many providers offer a portable option, allowing you to take the mortgage with you should you move house.
They are also more flexible in terms of age - some companies will lend to homeowners from the age of 55.
Disadvantages
The big downside with a lifetime mortgage is compound interest (where interest is charged on interest). This means that if you hold the loan for a long period of time, the debt can grow very quickly.
In the worst case scenario, the value of the loan could exceed the value of your property when you pass away, leaving nothing for your family to inherit. However, it should be noted that house price increases usually mean that this is not the case.
You may also be liable to pay more tax, if you use the loan as an income and any State benefits may be affected. It is also important to be aware that if you pay the loan off early, you may be forced to pay a hefty early repayment fee.
Home Reversion Schemes
Another common form of equity release is the home reversion plan. This is where you sell your home, or a percentage of it, to the provider but are able to remain in your property, rent-free, as long as you live.
Should both you and your spouse die or move into long term care, the reversion company can sell the property and are reimbursed.
Again, the cash can be paid in a lump sum or a monthly income (or as a combination) and how much you receive will depend on various factors, most importantly your age, but reversion plans usually offer somewhere between 20 and 60 per cent of the value of the property. Interest is not charged on reversion schemes.
Advantages
The obvious advantage of a home reversion plan is that you make no repayments and there is no interest to pay. In general, it is possible to release more equity than with a lifetime mortgage and should you need extra cash any point, it may be possible to sell a further percentage of your property's value.
Those who suffer with ill health will generally allow you to borrow more money. It is also important to note that the retained percentage of your home is yours to divide between your beneficiaries and therefore, they may benefit from any increase in property values.
Disadvantages
On the flip side of the coin, when your home is eventually sold, your family will not receive the full market value of the property as the reversion company will take back their percentage from the sale.
Home reversion plans are not portable either, so even if you decide to downsize, you will not receive the full amount made from the sale of your existing home. Bear in mind too, that the property must be well maintained. If it is not in a satisfactory condition, the company may carry out work and bill you for the labour.
In some cases, a reversion plan will be automatically terminated if you move into long term care and most firms will only allow you to sign up to a scheme if your home is in good condition and saleable.
Again, you may be forced to pay more income tax and your State benefits may be affected.
Equity release plans can be complex and it is essential that you make the right decision. Though most of us would prefer to retire debt free rather than borrow when we turn 65, these plans do provide another option if you are unable to cope.
Whatever you choose to do, it is vital that you seek advice and help from an independent financial adviser and ensure that any plan you sign up for is regulated by the Financial Services Authority (FSA) and, ideally, is approved by the industry trade body Safe Home Income Plans (SHIP).
