Equity release: a boost to retirement income?

If you own your property outright, or don't have much of your mortgage left to pay, you could make use of a lifetime mortgage, which allows you to borrow against the value of your home. These account for the vast majority of the equity-release market because very few providers offer the second option available - home reversion plans that allow you to sell all or part of your home.

Last year the amount lent under these schemes was a record £2.15bn, according to the Equity Release Council, the industry body for the sector.

"The main reason is the shortfall in pension income many people face in retirement," says Will Hale, business development director at equity release specialist Key Partnerships. "Unless you are lucky enough to enjoy the benefits of a final-salary pension, it is increasingly unlikely that your pension savings will support the lifestyle you want in retirement. Research by Prudential reveals that we want an income of £21,120 a year in retirement, but the average is £18,700 a year. That's a shortfall of £2,420 every year. And this doesn't factor in things such as holidays or meeting big, one-off expenses such as home improvements or buying a car."

The main three reasons Key Partnerships' customers typically use equity release are home improvements, repaying debts and mortgages, and holidays.

"There are 600,000 people with interest-only mortgages maturing in the next three years with an average outstanding balance of £55,000," continues Mr Hale. "Equity release is becoming an increasingly popular way to repay interest-only mortgages or other forms of debt carried into retirement, such as credit cards or loans."

Increasingly people are also using these products during a divorce or separation as it enables one partner to remain in the home while allowing joint property wealth to be shared. And with so many young people struggling to get on the housing ladder, some parents and grandparents are using equity release to help younger relatives with a deposit.

Equity release benefits

A key benefit of equity release is that the money released from these products is tax-free. And unlike an ordinary mortgage, you will generally not need to make monthly repayments, which is helpful if you are trying to minimise your outgoings. And as you continue to own the property you should benefit from any future increases in its value.

Gary Smith, chartered financial planner at Tilney Financial Planning, thinks equity release is a good way to generate income in retirement, particularly if you don't have children and are not concerned about passing on your property.

Following a mis-selling scandal in the early 1990s, the industry has brought in a number of standards to protect consumers, and is also regulated by the Financial Conduct Authority (FCA). "The legislation around this area has improved dramatically, it's no longer the Wild West," says Mr Smith.

Around 95 per cent of equity release lending in the UK is originated by providers who are members of the Equity Release Council and must comply with several rules, including:

■ Interest rates should be fixed, or if they are variable have a cap that is fixed for the life of the loan.

■ Borrowers must have the right to remain in their property for life or until they need to move into long-term care, provided the property remains their main residence and they abide by the terms and conditions of their contract.

■ Borrowers have the right to move to another property as long as it is acceptable to their product provider as continuing security for the equity release loan.

■ The product must have a no negative equity guarantee. This means that when your property is sold, and agents' and solicitors' fees have been paid, even if the amount left is not enough to repay the outstanding loan to your provider, neither you or your estate will be liable to pay more.

The flexibility of products is also improving. For example, many plans offer flexible repayment options if people receive inheritances or other windfalls later in life, and drawdown lifetime mortgages allow you to control how much money you take and when. They do this by providing you with an initial advance, together with an approved cash facility that you can draw on as and when you need. Interest is then only charged on the amount you take rather than the full amount available to you.

Compounding interest rates and high costs

The interest charged on an equity release loan is compounded or rolled up every year, with the amount of interest charged added to the loan. The interest for the following year is then worked out on the sum of the original loans, plus the interest that was charged during that year. This means that although the interest rate will remain the same each year, it will be calculated on a larger amount each time. As a result, the amount you owe will generally double every 12 years.

With a standard mortgage typically the interest does not compound. 

Example of how interest compounds on a lifetime mortgage of £50,000 with a 6% interest rate

Source: Equity Release Council

Lifetime mortgages are also more expensive than standard mortgages, with an average fixed interest rate for equity release deals of 5.55 per cent a year, according to moneyfacts.co.uk, although this is the lowest since records began in 2008. By contrast, the average two-year fixed mortgage rate is 2.3 per cent, the average rate for a lifetime tracker mortgage is 3.05 per cent and the average standard variable-rate mortgage is 4.59 per cent.

Lifetime mortgages are intended for life, so they are not designed to be repaid until you die or go into a care home. This means plans can have significant early repayment charges.

"It is more expensive than a standard mortgage, but with that there's always the risk that you could lose your home which is practically impossible with equity release," says Nigel Waterson, chairman of the Equity Release Council. "Additionally, the protections that are in place to manage the contract - ie, security of tenure, and no negative equity guarantee - cost the provider company significant funds to set up and maintain."

For this reason, Colin Low, a chartered financial planner and the managing director of Kingsfleet Wealth, thinks equity release should be the very last option people consider, if they want to increase their income in retirement.

"It needs lots of planning and not just by the individual themselves but the whole family," he says. "The accrual rate of interest is often very high and it doesn't take long for the interest to add up."

In the worst-case scenario, paying off the lifetime mortgage loan can swallow up the entire value of your home, leaving no property to pass to your heirs. So, if you are concerned about passing on a property, you may want to turn to other assets such as savings, investments or your pension to boost your retirement income before considering equity release.

"The later in life you do equity release the better [as the less time the interest rate has to accrue]," says Mr Smith. "If you are in poor health, for example, you might want to consider it, but if you're in your 50s, don't have an immediate financial need and just want to raise capital, you're pretty much ensuring that 100 per cent of the house will go to the provider after you die."

Although you are able to move property, if you have taken out a lifetime mortgage there are restrictions on the type of property the mortgage can be transferred to. And your provider needs to confirm that your new home will be acceptable to them as continuing security for the equity release loan. The Equity Release Council says studio flats, retirement properties or basement flats are examples of properties unlikely to be acceptable.

Lifetime mortgages with lowest interest rates

Source: www.moneyfacts.co.uk, as at 2/06/17