If you're looking to address a pension shortfall, or want to make home improvements, it can appear attractive. It promises money in your pocket with no monthly repayments.
However, it's also an expensive lifetime commitment which can end up costing you your entire home.
Here we explain how and when to consider it.
How it works
If you take chunks of cash when you need it – known as income drawdown – you only pay interest (which can vary each year) on the money you’ve taken.
Either approach can be very expensive as the interest ‘rolls up’ year-on-year. As long as the provider is registered with the Equity Release Council (ERC), the debt will never exceed the value of the property – but you won’t be able to pass on your home.
It’s possible to pay off a lifetime mortgage early, but there are often steep penalties for doing so. You can usually make partial repayments each year penalty-free though.
Find out more:Is it worth it?
We’ve crafted three scenarios – two lump sum and one drawdown – to show what taking out a lifetime mortgage could mean for your finances and your home.
In each case we used the following assumptions: an annual fixed interest rate of 7% (the market average on 2 April, according to Moneyfacts), a property value of £280,660 (February UK average, HM Land Registry), and annual house price growth of 4.32% (based on average annual house price growth over the past five years, HM Land Registry).
Scenario 1 – Extending your home
Let’s say you decide to borrow this amount through a lifetime mortgage held against your home. This amounts to an 18.4% LTV (loan to value ratio).
After 10 years, your debt will already have almost doubled to £101,800. In the case of a 65-year-old who lives until the age of 85, the debt pile will have ballooned to £200,256, or 30.6% of the value of their home.
For a 55-year-old, it will have swelled to an eye-watering £393,934 by age 85 and would consume nearly 40% of their home’s value.
Bear in mind this assumes a fairly buoyant property market where your home’s value grows by 4.32% each year – far from guaranteed.
A more subdued market with an annual growth rate of 2% would see a 65-year-old owing nearly half the value of their home. A 55-year-old would end up on the hook for more than three quarters of their home’s value (77.5%).
Home extension - proportion of your home you'd own by age 85
Scenario 2 – Helping family
A typical example of helping a family member would be giving a younger relative enough money to get onto the housing ladder.
For a 65-year-old, by the time they reach 85 the debt will have grown to £133,504, or 20.4% of their property’s eventual value.
For a 55-year-old, the debt will hit £262,623 by the time they reach 85, equal to just over a quarter (26.3%) of their home’s value.
In a more subdued market, the sums are far less favourable. The 65-year old would end up owing just under a third of their home’s value and the 55-year old over half.
As a quick example of how even small partial repayments can dramatically reduce your final bill; if our 55-year-old were to pay back just £1,200 each year, their final debt would be £141,335 instead of £262,623.
Helping family - proportion of your home you'd own by age 85
Scenario 3 – Funding retirement
Let’s say you want to fund 25% (£5,000) of that each year through an equity release drawdown loan, to top up income from pensions.
Drawdown equity release works slightly differently in that you only pay interest on the amount you ‘draw’, while the rest sits in reserve. Interest rates are usually variable. For simplicity’s sake we’ll assume a rate of 7% each year.
A 65-year-old wanting to draw £5,000 each year would end up with debts of £224,326 by the time they reach 85, equal to just over a third of their home’s eventual value.
A 55-year-old would end up owing a huge £510,365, equal to 51.1% of their home’s value.
It’s here that the risk posed by a subdued property market becomes unnervingly apparent.
We found the 55-year-old would owe 100.4% of their home’s value – though at least with the ERC’s rule that the debt can’t exceed the home’s value, this falls to 100%. The 65-year-old would owe 53.8% of their home’s value.
Funding retirement - proportion of your home you'd own by age 85
What are the alternatives?
Equity release is most suitable if you’re older, own an expensive property outright that’s expected to increase in value, and you don’t intend to pass it on when you die.
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source https://www.which.co.uk/news/article/when-is-equity-release-worth-it-aOuCG9u7amTV