If you find yourself “asset rich and cash poor”, many over 55s opt into an equity release scheme (ERS) to raise some extra cash, but it’s not all good news. ERSs have been labelled “the lifestyle dream that can turn into a nightmare” by consumer organisation Which?, who warn that the scheme could leave pensioners owning hardly any of the value in their home, contrary of popular belief. In this post we outline what equity release is and the pitfalls of equity release in the UK.
What is equity release?
Equity release allows you to access the equity (cash) tied up in your home if you are over the age of 55 years old. You can take the equity release in a full lump sum, in smaller amounts over time, or even both.
It is worth bearing in mind that if you have family to pass your assets onto once you pass away, equity release generally means there will be less for them to inherit. This is because however much equity you release from your home will come with interest, which must be paid back once you die. This is one of the major pitfalls of equity release schemes which isn’t widely understood.
How does equity release work?
Often you have two equity release options:
– Lifetime mortgage
This is the most common form of equity release is the lifetime mortgage, which allows you to access equity built up in your home. You can choose to make repayments or let the interest increase over time, it is entirely up to you and your financial situation. The loan amount and any interest is paid back at the end of the scheme, when you die or when you move into long-term care.
However it’s worth noting that there are pitfalls of equity release that may affect how it works for you. For example, if you choose to let the interest mount up, this means that you will owe a significant amount of money after you die and, in some cases, if you live for a long time after you have taken out your plan, the total debt you owe may exceed the value of your home.
Reputable providers should offer a no negative-equity guarantee, which means neither you or your family will have to repay more than your property is worth. Be sure to look out for this in any documentation.
Furthermore, another disadvantage of equity release is that sometimes the amount you can release can be limited, which is an issue if you need cash fast. Generally speaking, the younger you are and the better state of health you are in when you sign up to an equity release scheme, the less equity you will be able to unlock.
– Home reversion
This equity release option means you sell part or all of your home to a home reversion provider in return for a lump sum or smaller regular payments over time. Despite selling your home, you are allowed to continue living inside the property until you die, on the exception that you have to agree to maintain and insure it.
In this instance, if you’ve sold 100% ownership of your home, when you die your family will not get anything from your home as inheritance.
If you choose to go ahead with an equity release scheme, please be sure to carry out sufficient research and always remember to read the small print – and if you don’t understand anything, ask a professional for advice!
Read on to get more clued up about the pitfalls of equity release.
How much does equity release cost?
The lifetime mortgage equity release typically comes with a rate of 5%, although some can be under 3%. This is cheaper than rates have been in previous years and significantly higher than most standard mortgage deals.
The cost comes from repayments, as if you cannot afford to make monthly repayments to reduce your debt, the interest increases more and more.
For instance, if you borrow £20,000 aged 60 at 5.1% on a £120,000 home, the amount you owe will double roughly around every 14 years. This means that the longer you live, the more you owe.
For instance, if you live until 64 years old you will owe around £40,000, or if you live until you are 88 you will owe £80,000.
On top of this, another pitfall of equity release is that you will also need to pay for arrangement fees which can be anywhere between £1,500 and £3,000 in total, depending on your plan.
What are the alternatives to equity release schemes?
After reading all about the pitfalls of equity release, if you are a homeowner over 55 looking to raise money quickly, there are many other options worth considering. Deciding which option to go for will depend on your current finances, how much you want to raise and how quickly you need it.
1. Credit
If you only require a small amount of money quickly, it may be worth taking out a personal loan. For instance, if you want to borrow £10,000 and repay within 12 months, interest rates can be fairly low – shop around for the best deal available.
Alternatively, an even cheaper option would be to take out a credit card with a low interest rate, which can be helpful if you want to take out even smaller sums.
2. Remortgaging
Remortgaging your property may enable you to borrow more than a loan or other mortgage types, such as a retirement interest-only plan.
However, with this option, you may find some high street banks refuse to remortgage people over a certain age. Despite this, this is changing slowly with smaller building societies leading the change, so it’s well worth doing your research.
3. Downsize
Another alternative option to equity release is to sell your home and move to a cheaper one, which is known as “downsizing”. This enables you to pocket the difference between the two homes, leaving you with some extra cash in the bank. To do this, you may wish to sell your home fast for a good price with a quick sale company that pays you via cash – this is particularly useful if you are facing financial difficulties.
Downsizing may appeal to older homeowners whose children have flown the nest and have no tiebacks, meaning they can move into a smaller property, such as a one-bedroom bungalow for instance. Here are 5 benefits of downsizing to a smaller home.
4. Rent out a room
If you have no urgent need for money but would like some extra cash over time, you may want to consider renting out a room in your home. Not only can this help with raising extra money, but it can also help with loneliness which is common among the older generation.
This can take on the form of short-term lets, such as bed and breakfast or holiday lets (such as Air BnB). Depending on where you live, such as in a tourist hotspot or by the seaside, this may be a great way to earn some money.
Alternatively, you can take a lodger. The Government’s Rent a Room scheme lets individuals earn up to £7,500 a year tax free if you have furnished rooms you can let. However, this drops to £3,750 tax-free if you share the income with your partner or a third party.
Feature image credit: William Potter / Shutterstock
