- Equity release can help to pass on an early inheritance or enhance your standard of living in retirement
- But it is expensive, can be inflexible and doesn’t necessarily have IHT benefits
- Alternative options include maximising your pension and downsizing
Equity release doesn’t have a great reputation. It was the “problem child that the wider sector didn’t like to talk about”, according to a recent report commissioned by the Equity Release Council, a trade body. However, equity release has changed a lot in the past two decades and, as the cost of living rises and retiring becomes more expensive, it is one of a number of ways to release cash from your property.
Equity release is a way to access cash ‘trapped’ in your property without having to move out or downsize. Equity release products include lifetime mortgages, through which you borrow against the value of your home and which are repaid when your home is sold on your death or when you go into permanent care. Interest-only retirement mortgages work in a similar way, but you pay back the interest over time so it does not compound. Home reversion plans, meanwhile, involve a company taking a percentage share of your home in exchange for cash. Once more common, home reversion plans currently make up less than 1 per cent of equity release sales.
Doug Brodie, founder and chief executive of retirement planning firm Chancery Lane, says that because of substantial increases in house prices over the past few decades, equity release can be a way to put some of that wealth to good use while you are still alive. With current life expectancy, people tend to inherit when they have already retired, while younger generations struggle to become homeowners. “The time to pass down an inheritance is when people need the money,” he says.
Equity release can also help to improve the quality of your retirement. As maintaining a comfortable retirement living standard becomes more expensive, people find themselves with homes that are worth a lot, but less lavish pension incomes to maintain them and to live on. “It’s a bit pointless, living your life in retirement being asset rich and cash poor,” adds Brodie.
Spending your home’s value rather than your pension has advantages. Cash you get via equity release is tax-free, but money you draw from pensions can be subject to income tax. And, unlike your home, pensions are not subject to inheritance tax (IHT) so can be a good way to leave assets to your children.
Cash at a price
The equity release industry has been regulated since 2004, and products now offer negative equity protection so that you or your beneficiaries don’t risk having to pay back more than what your house is worth – even if house prices go down. And drawdown lifetime mortgages, which allow people to take what they need in tranches from their equity release facility and only charge interest on the amounts withdrawn, have become widely available. “Equity release now is completely different to the market that baby boomers grew up with,” says Brodie.
But equity release also has various drawbacks, so consider all the alternatives first and take financial advice before proceeding. Karen Noye, a mortgage expert at Quilter, adds that equity release “carries potential risks and may not be suitable for everyone."
Equity release is relatively expensive, with higher interest rates than those of a typical mortgage. This is particularly significant now that interest rates generally are higher. The cost reduces the amount of cash you receive, and ultimately erodes the value of your property and how much you can pass to your beneficiaries. Many providers offer inheritance protection, which ringfences a portion of the equity to be passed on to beneficiaries, but this also comes at a price and cuts the amount you can release. Brodie argues that equity release only makes sense if you are over age 75 as before then the effect of compound interest means the costs tend to outweigh the benefits.
The lending criteria for equity release is more stringent than for conventional residential mortgages, mostly because it isn’t the individual’s income that will repay the loan but the property value. Properties that meet the standard for residential mortgage loans can be rejected for equity release, for example because of the percentage of flat roof or proximity to commercial premises.
Flexibility is also an issue. “If homeowners decide to repay their equity release loan ahead of schedule, they may face hefty early repayment charges, which could negate the benefits of repaying the loan early,” says Noye. Early repayment charges used to have variable rates, linked to the yield on government borrowing. They now mostly have fixed rates, but can still amount to up to 25 per cent of the amount borrowed, according to a report commissioned by the Equity Release Council.
All equity release products now allow you to move house, although subject to the new property being acceptable to your provider as continuing security for the loan, which could reduce your choice. And many products offer downside protection, which lets you repay the loan without penalty and move to another provider that will accept the property.
Equity release can be a way to reduce the amount of IHT your estate will be liable for because you could gift some of the cash you release to beneficiaries. However, gifts are only free of IHT if you live for seven years after making them, so if you pass away before then your beneficiaries might still owe IHT if it is not offset by other allowances. And, importantly, the cost of equity release eats away a significant portion of the value of your home, potentially wiping away some or all of the savings made on IHT.
Dawn Mealing, head of advice policy and development at Fidelity International, says that you should also think about how equity release might impact the £175,000 residence nil-rate band which you can get on top of the £325,000 IHT allowance if you leave your home to children and/or grandchildren. So don’t take out an equity release product just to reduce your IHT liability because it could be a false economy.
If you do opt for equity release, Tom Selby, AJ Bell’s head of retirement policy, says that you should declare any health or lifestyle factors that might affect your life expectancy, as this could result in you being offered a better deal. Only drawing down what you need when you need it, buying inheritance protection and opting for an interest-only mortgage are ways of potentially reducing some of the drawbacks of equity release.
