EQUITY RELEASE.
UNLOCKING MONEY FROM YOUR HOME
Equity Release plans
– an overview
The issues
surrounding pensions in the UK affects us all, but it is already
a very real and daily challenge for millions of retired Britons.
However, many
retired people who manage on a small pension and limited savings
are also living in properties which have soared in value in
recent years and with the average house price in England and
Wales now standing at £199,184 (Land Registry figures for August
2006), people may be not be aware of the true value of their
home.
Equity release plans
– also called lifetime mortgages, home reversion or home income
plans – are a way of releasing cash, whether to buy that new
car, to pay for a holiday or home improvements, or simply to
make daily life more comfortable. These schemes essentially
allow you to borrow money against the value of your home, with
the debt being repaid from the sale proceeds after your death.
How they work
While there are a
range of different schemes offering lump sums and/or regular
income, they all work on the same principle: they lend you a
part of your home’s value in return for a share of the proceeds
when you die.
In most cases you
will need to be at least 60 years old, have no outstanding
mortgage (or you will need to use the equity release money to
pay down the existing loan), and own a property in reasonable
condition.
Equity release plans
can be complicated products and are a major step for many
people. Your house is almost certainly the most expensive asset
you own; it is also your home. Good advice is therefore key.
Age Concern and the
Financial Services Authority, the UK’s chief financial watchdog,
both recommend getting independent financial advice before
proceeding.
An Independent
Financial Adviser (IFA) will look at your overall finances to
see if equity release is really the best option for you, help
find the right type of scheme – bearing in mind that in some
cases you could risk losing state benefits and may have to pay
extra tax. See page 14 for details of how to find an IFA.
Equity Release plans
– their attractive features.
• They can
give a lump sum, a regular income or both. The lump sum could be
tens of thousands of pounds; the income boost might be worth as
much as a hundred pounds a month or even more.
• Money
released from the value of your principle residence is free of
tax, although if the cash is then invested there may be tax to
pay on any income or growth.
• You
don’t have to move house or sell your home to unlock equity.
With reputable equity release schemes there is a rock-solid
guarantee that you will be able to continue to live in and enjoy
your home until the day you die – and in many cases still be
able to leave something of the property’s value to your family.
Of course, if you
don’t have children or family to leave your property to, then
equity release might seem an even more attractive concept.
• They can
also be a way of cutting inheritance tax bills. Inheritance tax
kicks in at 40% on everything left behind over £300,000
(2007/2008). Importantly, that figure includes the value of your
home.
The value of many
properties means that IHT is no longer something only the rich
have to pay. Equity release plans are a perfectly legal way of
mitigating inheritance tax. They could be used, for example, to
give a child or grandchild the deposit to buy their own
property.
• They can
also be used to pay for care bills without having to sell up at
what can be a traumatic enough time.
Equity release will
not suit everyone. It is always worth considering whether funds
could be raised affordably from other sources before going down
this route.
According to Norwich
Union, one of the increasing number of financial services
companies offering
equity release plans, in October 2002 1 in 10 homeowners aged
55-70 were looking to release equity as a means of boosting
their retirement income. It can be expected that many more
people will look to release equity from their properties while
interest rates remain low, mortgages are paid off and house
prices remain stable.
Types of Equity
Release schemes.
Here are the main
equity release schemes with their pros and cons:
Home reversion
schemes
You sell your home
or a share of it to a reversion company for a lump sum or in
return for a monthly income (or a combination of both).
Technically you
become a tenant, albeit with the right to continue living in
your home rent-free (or sometimes for a nominal rent) for the
rest of your life.
When the property is
sold – usually when you die – the reversion company gets its
payout. If, for example, you sold 50% of your property to the
reversion company, it gets 50% of the proceeds – including any
growth. If you sold 25% of your property, it gets 25% of the
proceeds, and so on.
In addition, the
reversion company will also only pay you a percentage of the
current market value for the share of your property it buys.
This is because you get to carry on living in the property until
you die, and the company may have to wait years for its return.
If you sell all of
your property to the reversion company, for example, you will
typically get between 30% and 50% of its current value. It will
rarely be more than 60%. The actual figure will depend on your
age (and your partner’s). Older people will get more, and men
get more than women – because of differences in how long they
are expected to live.
Pros
• No
ongoing repayments to make, the reversion company makes all of
its money when the property is sold.
• You know
at outset what share of your home (if not its value) you will be
leaving to your family.
• You
continue to share in any rise in the value of your property
(unless you have sold its entire value).
• You can
take extra cash advances, depending on the amount you originally
took.
• If you
are a smoker or have a serious illness, you may be able to get a
bigger payment.
Cons
• The
reversion company will buy at a discount to the current market
value. The big discount at which the reversion company will want
to buy makes these schemes less suitable for people in
their 60s.
• If you
die soon after taking out a plan, you could effectively have
sold off your house (or a share of it) on the cheap. Some
schemes give families a rebate if you die within the first few
years of signing up.
•
Reversion companies can be choosy about the properties they
take.
Interest-only
mortgages
You borrow a lump
sum secured against the value of your home. You pay interest
each month, but you have a lump sum to spend as you wish. The
capital is eventually repaid out of the sale proceeds.
Pros
• The
amount you owe is fixed so any increase in the value of your
home belongs to you or your family.
• You can
borrow at a fixed rate so you know exactly what you have to pay
every month.
Cons
• You need
to be able to afford the ongoing interest payments: you should
think about investing the lump sum you borrow.
• Many
schemes involve buying an annuity. Because annuity rates are so
low and they increase with age, these schemes are often only
suitable for elderly homeowners.
• Variable
rate loans can be very risky: your payments could rise more than
your pension or other income.
Home income plans
These used to be the
most popular type of equity release plans. You take out a
mortgage against your home and use the money to buy an annuity
which guarantees you an income for life. Mortgage payments are
deducted from this monthly income, although the original capital
is only repaid from the sale proceeds, normally after you die.
Pros
• Regular
income for life, and the mortgage interest is deducted
automatically.
• The
amount you owe is fixed and any increase in the value of your
home belongs to you or your family.
Cons
• Not
suitable for those looking for a substantial lump sum.
• Income
is normally fixed at outset, so will be eroded by inflation.
• Built-in
annuities are not the most competitive – you are generally
better
off shopping around
for an annuity (if the plan permits this) or investing the money
elsewhere.
Lifetime mortgages
The lender gives you
a lump sum or monthly income (or both). You pay nothing – the
interest is ‘rolled up’ into the loan. The amount borrowed plus
this interest is repaid out of the proceeds from the sale of the
property after you die.
How much you can
borrow depends on the value of your home and your age – the
older you are, the higher the percentage of your property’s
value you can borrow. Generally, you will not be advanced more
than 50% of the value of the property.
Pros
• No
interest payable while you are alive, so you will get a higher
income for the same sized loan than with an interest-only
mortgage or home income plan.
• Most
loans are fixed-interest, so reducing risk.
• Plans
are available to people as young as 55.
• The
provider of a lifetime mortgage will be authorised and regulated
by the Financial Services Authority.
Cons
• The
uncertainty about how much will have to be repaid at the end –
and how much will be left for your family.
• Interest
payments can mount up quickly and will further reduce what your
family will inherit. Your family could end up with nothing from
the sale proceeds even though the lump sum you were lent only
seemed a fairly small proportion of the home’s value.
• Interest
rates can be high.
• You may
not be able to get a top-up loan later.
Shared appreciation
mortgages
These are not
currently available but have been popular in the past and may be
available again in the future. You borrow a lump sum based on
the value of your home; there are no repayments until you die or
the property is sold. Then the amount you originally borrowed is
paid back plus an agreed percentage of the amount by which the
home has increased in value.
Pros
• No
regular repayments to make.
• The loan
could end up costing nothing if your home’s value has not
increased or if it has fallen.
Cons
• If house
prices rise strongly, the effective cost of the loan could be
very high.
• If you
need to move home in the future after a period of strongly
rising house prices, you may find that you can only afford a
much smaller/cheaper property.
Important points
Your family
While equity release
plans can be a good way of cutting inheritance tax bills, they
will also reduce what your family will inherit.
While it should
ultimately be your choice whether to sign up to a scheme, it is
probably a good idea to discuss it with close family members
and/or anyone who might have expected to inherit your home. This
may help avoid any unpleasantness or misunderstandings.
If the property has
been a family home for a long time, bear in mind that your
children or other relatives may also have an emotional
attachment to it. They may even have been thinking of living in
the property after you die.
Children or other
relatives may be prepared to help you out financially instead of
you taking out an equity release plan. They could then inherit
the whole property. An IFA will be able to advise on any tax
issues involved.
Alternatives
You may have other
assets or investments which could boost your income or give you
the lump sum you need. An IFA will be able to take a holistic
view of your finances.
Consider, too,
whether moving to a less expensive property might be a better
way of releasing money tied up in your home – rather than
letting an equity release company profit from your
bricks-and-mortar investment.
Benefits
If you receive
means-tested state benefits, these could be reduced or lost
altogether – which in turn could mean having to pay more for
things like dental treatment and glasses. Check the rules before
you take out an equity release plan.
How to avoid any
risk
Look for plans
carrying the SHIP logo (for Safe Home Income Plans). SHIP (0870
241 6060) is an industry body set up to promote safe equity
release schemes. Companies who are members provide a number of
guarantees, including: you will have the right to live in your
property for life; the freedom to move to an alternative
property without penalties; and that you will never owe more
than the value of your home.
If the scheme’s
income comes from an annuity, you’ll get a better rate the older
you are.
If you are just
retired, it may be worth waiting a few years before signing up
to an equity release scheme in order to get a better deal.
Equally if you are
very old or in poor health you should think carefully about
schemes paying monthly incomes – you may not live long enough to
get a decent return.
Costs
The equity release
market is becoming more competitive. But interest rates on
mortgage-based schemes, for example, are still noticeably higher
than those on ordinary mortgages. Most equity release plans also
involve paying valuation and legal fees, although these may be
refunded assuming you go ahead. You remain responsible for
repairing and insuring your home, and will still have to pay the
Council Tax. Reversion companies in particular will expect you
to maintain your home to a reasonable standard to protect their
investment.
Can you move or sell
up?
You may want to sell
your house at a later date and move somewhere smaller or more
suitable for your needs, or you may want to sell up completely
to move into rented sheltered housing or into a care home. You
should check whether any plan you are considering allows you to
transfer it to a new property or whether there is a penalty if
you end the scheme before death.
Advice
Getting independent
financial and legal advice before taking out an equity release
plan is recommended by both the charity Age Concern and the
Financial Services Authority, the UK’s chief financial watchdog.
For details of local IFAs who can advise you on a wide range of
financial services, call the IFA Promotion free phone Hotline on
0800 085 3250 or visit
www.unbiased.co.uk
For further
information on the subject contained in this guide, please
contact your IFA.
If you do not
already have an IFA, our ‘Find an IFA’ hotlines and website
enable you to confidentially search for a list of IFAs in your
local area. You can search for an IFA based on a whole host of
criteria (including product, qualifications, gender and payment
options) so you can be sure you’ll find an IFA that meets your
precise requirements.
