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Fees & Funding > How Does Equity Release Work? The Different Types

How Does Equity Release Work? The Different Types

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Sarah Farmer profile image
1/24/2023

Equity release allows homeowners aged 55 or older to release tax-free money from the value of their homes. How much money they’re able to release depends on their age and the value of their property. This money can then be claimed as one lump sum, or as several smaller payments.

Although equity release allows people to use the money they’ve built up in their property (without having to move or sell), it does come with certain risks.

In this article, we’ve explained what equity release is, how it works and whether it’s the right choice for you.


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In this article:

  1. What is equity release?
  2. Who is eligible for equity release?
  3. The different types of equity release
  4. How does equity release work?
  5. How much does it cost?
  6. Advantages and disadvantages
  7. Things to consider before getting an equity release
  8. Alternatives
  9. Can equity release be used to pay for care?
  10. Is equity release the right option for you?



What is Equity Release?

Through equity release, homeowners aged 55 and over can release tax-free money from the value of their homes. This is a long-term loan that will be eventually repaid using your home once you pass away or need to go into long-term care (such as a residential care home or nursing care home).


There are several reasons why people get an equity release, including:

  • Help children or other family members with financial difficulties or buying their own homes (you may also wish to help pay for other major events such as a wedding)
  • Fund leisure activities
  • Travel the world
  • Pay off an outstanding mortgage
  • Pay one-off private medical bills (or pay for ongoing home care)
  • Pay off any loans
  • Make home improvements
  • Have some extra income to make retirement living more enjoyable

Kensington Riverstone retirement community





Who is Eligible For Equity Release?

To be eligible, you must be at least 55 years old. This is the case for an equity release lifetime mortgage.

To be eligible for a home reversion plan, you may need to be at least 60 or 65 years old (this varies from provider to provider).


To be eligible, you’ll also need to meet the following criteria:

  • You own property in the UK which is classed as your main residence
  • Your property is above a particular value and is in good condition

We’ve gone over the different types of equity releases in the section below





The Different Types of Equity Release

There are two main types of equity release product. We’ve gone over both of these below:


Lifetime mortgage

This is a loan secured against your home and is the most common form of equity release. It allows you to release tax-free money without needing to move and is usually available to homeowners aged 55 and over. Money can be taken as one cash lump sum or several smaller sums.

You don’t repay anything on a lifetime mortgage until you pass away or permanently move into long-term care.

You can either make monthly payments on the interest rate or let the interest rate build up. If you do make payments, the amount of interest added throughout the mortgage will be less.


Home reversion

A home reversion scheme is often used to pay for long-term care, particularly when you plan on remaining at home.

You’ll sell all or part of your property at a below-market value in exchange for a tax-free lump sum or regular payments. Usually, you’ll get between 20% and 60% of the property’s market value (or of the part you sell).

For example, if you sell a 50% share in a £500,000 property in exchange for a lump sum of £125,000, the amount you receive is greatly discounted from the £250,000 this share is worth. The reason for this discount is that the provider will likely have to wait a long time to get the money back.

You’ll then remain at home as a tenant but won’t pay any rent.


Be sure to check the minimum age when considering a home reversion scheme. Some providers have a minimum age of 60 or 65. You’ll also want to find out the percentage of the market value you’ll receive, as well as how you go about releasing equity.


The following companies offer home reversion plans in the UK:




How Does Equity Release Work?

When getting an equity release, this is how the process normally works (although it may vary slightly from person to person):

  1. To start, you should speak with an expert financial adviser. They’ll make sure you’re eligible before explaining all the different options. This will help you figure out whether this is the right choice and if so, which option is best suited. They’ll likely recommend an equity release provider as well

  2. If you’re still set on equity release, the next step is appointing a specialist solicitor. This solicitor will offer independent equity release advice where needed

  3. Your adviser will help you submit your application to your chosen lender

  4. The lender will visit your home and value it

  5. The lender will send through the terms of the equity release scheme to your solicitor (once your valuation and application have been processed)

  6. If you’re happy with the offer, the lender will release the money to your solicitor through the method you agreed (e.g. as one lump sum amount or as several smaller amounts)

Woman sat at her desk behind a computer





How Much Does It Cost?

Money Saving Expert says that when considering all the costs associated with releasing equity, the total cost can end up being between £1,500 and £3,000.

The amount of variance in price can be put down to the number of variable factors, including things like different lenders charging different application fees and the same for solicitors.

Often, higher-value properties will incur higher fees across the board as well.


How much equity release costs also depends on how much interest you end up paying.





Advantages of Equity Release

Here are the biggest advantages associated with equity release:

  • It gives you money to spend right now, rather than having it tied up in your home
  • You don’t pay tax on the money you release
  • It allows you to remain in your own home and not have to make sacrifices like downsizing or moving to a cheaper area
  • You might have access to low-interest rates
  • You’ll never owe an amount greater than the value of your home
  • The loan doesn’t need to be repaid until you pass away or move out of your home and into long-term care
  • You can choose whether to make monthly repayments
  • You might be able to avoid paying inheritance tax (though the rules around this are complex, so seek professional equity release advice before making any decisions)
  • You can still move house after getting an equity release

Disadvantages of Equity Release

And here are the biggest disadvantages associated with equity release:

  • Your benefits and eligibility for them may be affected (more on this later)
  • Interest rates will increase the amount you owe
  • There are often set-up fees and other legal fees
  • You could also have to pay an early repayment charge
  • You won’t be able to leave your home as inheritance
  • You won’t be able to take out another loan against your house
  • Your family may have to pay inheritance tax on any money you gift them
  • Similarly, the inheritance you leave will be reduced



Things to Consider Before Getting an Equity Release

Here are a few other things you should know about and consider before deciding if an equity release scheme is the right option for you.


Cost

There are lots of different costs involved with equity release schemes. These include:

  • Interest rates - The lowest is currently at 6.1%

  • Valuation fees - An independent surveyor will value your house

  • Arrangement fees - A fee for setting up the scheme to begin with. This could either be a fixed price (e.g. £1,000) or a percentage of the loan amount)

  • Solicitors fees - These will vary, depending on how much time you spend with your solicitor and the level of service they provide

  • Consultation fees - This is a fee your broker will charge for their services. Just like arrangement fees, this could either be a one-off payment or a percentage of the equity release amount (usually around 1.9%)


How your ability to claim benefits will be affected

In theory, equity release can affect any benefits you currently receive. It can also affect any benefits you may receive in the future.


This is particularly true for means-tested benefits, some care home benefits and certain carer benefits, including:

  • Pension Credit
  • Jobseeker’s Allowance
  • Universal Credit
  • Council Tax Support
  • Income Support

However, if you release equity from your home to pay off your mortgage or any loans, these funds will likely be paid directly to the mortgage company or loan company. So, any money released for this reason won’t affect your benefits (including means-tested ones).

If you release money as cash and don’t spend it on anything, you may pass the savings threshold and see some or all of your entitlement to benefits affected.


How your inheritance tax will be affected

Unless you have a surviving spouse or civil partner to inherit your estate, your beneficiaries will often have to pay inheritance tax of 40% on assets and other wealth above £325,000 when you pass away.

Money used from the sale of your property to repay the equity release loan is subtracted from the inheritance, so isn’t liable for inheritance tax.


Negative equity

Negative equity is when your property becomes worth less than the remaining value of your mortgage. To get around this, many lifetime mortgages have a ‘no equity guarantee’ or ‘negative equity guarantee’. This means when your property is sold, your estate won’t have to pay the extra cost if there isn’t enough to repay what’s owed.





Alternatives

There are several alternatives to equity release schemes, including:

  • Downsizing by selling your current property and moving to a smaller one (many people say this is the most sensible alternative)
  • Renting out a room in your house for some extra financial income
  • Continue earning (not necessarily through full-time employment, but potentially through a side hustle or hobby that can earn you money)
  • Get a retirement interest-only mortgage
  • Get a personal loan or credit card (you may want to seek out independent legal advice before doing this)
  • Get help from family members
  • Take advantage of state benefits if you’re eligible
  • Use any other savings you have



Can Equity Release Be Used To Pay For Care?

Yes - equity release is designed to create additional income, so it can be useful if you have to pay for care.





Is Equity Release the Right Option For You?

Though equity release isn’t the right option for everyone, for some people it’s perfect.

This is a highly regulated and really popular way of accessing money tied up in a property (which depending on your financial situation, can prove invaluable). Being able to access this money can help you do lots of things, including making home improvements, helping out your loved ones or paying off other loans.


If you’re unsure as to whether it’s the right option for you, be sure to speak to a qualified financial adviser. They’ll discuss whether you’ll benefit or not. If the answer is yes, they can then discuss which type of equity release will be best suited (e.g. a lifetime mortgage or home reversion), depending on your individual circumstances.






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