When looking to raise capital from your home, the two main options are to remortgage or look at equity release. While both options will provide an immediate release of capital, the short, medium and long-term repercussions are different. Therefore, it is essential to be aware of the distinct differences and how these may impact your finances.
Everything you need to know about remortgaging
The concept of remortgaging is straightforward and can take one of three forms:
- Remortgaging your home to take advantage of lower interest rates
- Remortgaging your home to release equity
- A mixture of the two
In this instance, we are focusing on remortgaging your home to release equity. The idea is simple and best demonstrated with an example.
Example of remortgaging your home
In this example, we will look at a property acquired some time ago, which has increased in value, and the opportunity to remortgage.
Value at purchase: £100,000
Loan to value (LTV) ratio: 75%
As most mortgages involve monthly repayment of capital and interest, let’s assume that the outstanding mortgage now stands at £50,000. The property has also increased in value to £200,000:
Current value: £200,000
Outstanding mortgage: £50,000
LTV ratio: 25%
There is £150,000 of equity in the home in this scenario due to the reduced mortgage and the increased value. Using an LTV ratio of 75%, there is the potential to remortgage the property to raise £150,000 - part of this will be used to repay the existing mortgage. Consequently, the scenario is as follows:
Current value: £200,000
Payment of outstanding mortgage: £50,000
Net funds raised: £100,000
Remaining equity in home: £50,000
There are many pros and cons regarding remortgaging, which will dictate whether this is the most appropriate option in your situation.
Pros and cons of remortgaging
Pros of remortgaging
When looking at remortgaging to release equity from your home, there are several positive aspects to consider:
- Opportunity to benefit from lower interest rates
- Ability to use your improved finances to maximise mortgage funding/equity release
- Equity funds upfront, repayment spread over the long term
- Remaining equity will act as a buffer between outstanding mortgage and property value
- Option to use equity release to pay off high-interest debts
The LTV ratio on any remortgage will depend on your age, finances at the time and ability to cover monthly repayments. It is important to remember that any mortgage application will need to pass the "affordability test", which is no different for remortgaging.
Cons of remortgaging
The ability to withdraw what is often significant equity from your home can be a welcome relief for so many different reasons. However, it is vital to be aware of the disadvantages of remortgaging:
- Your home is still at risk if you fail to cover the monthly mortgage payments
- There will be remortgage fees, although these are often lower when remortgaging with the same company
- Under the "affordability test," you may not be eligible to remortgage
- Even with a short-term fixed-rate, you are still exposed to long-term interest rate changes
- Long-term interest payments can be significant
While the idea of releasing substantial equity from your home, for whatever reason, may seem attractive, this still needs to be repaid. In addition, if your financial situation were to deteriorate in the future, your home may be at risk.
Everything you need to know about equity release
As the term suggests, equity release arrangements focus on those looking to extract funds from their home. There are two distinct options when it comes to equity release:
- Lifetime mortgage
- Home reversion scheme
While both will allow you to release equity relatively quickly, the impact on your finances is very different.
Example of a lifetime mortgage
When taking out a lifetime mortgage, you will still retain ownership of your home until the last borrower dies or moves into long-term care. At this point, the property would be sold, the lifetime mortgage repaid, and any excess capital returned to the borrower or their estate. So how does a lifetime mortgage work?
Lifetime mortgages tend to be popular with older homeowners who have seen a reduction in their income in retirement. The mortgage arrangement has no fixed duration, with the capital repaid when the last borrower dies or moves into long-term care. During this period, interest will accrue. This can be paid monthly or rolled up and repaid when the property is eventually sold. Many of those who choose lifetime mortgages will look to roll up the interest, which attracts an element of interest on interest.
As a consequence, the maximum LTV ratio on a lifetime mortgage is different to a traditional remortgage. While the rate will vary from lender to lender, these are two ballpark figures:
- Age 65, LTV ratio of between 25% and 30%
- Over 70, LTV ratio as high as 50%
There is a simple reason for the variation in maximum LTV ratios for different age groups. As younger borrowers are expected to live longer, the rolled-up interest charge would be more significant. Older people are less likely to accumulate the same level of rolled-up interest; consequently, a higher LTV may be available. The LTV ratio is directly related to a comfortable buffer between the outstanding mortgage, interest charges, and property value.
Example of a home reversion scheme
While there are numerous elements to consider with lifetime mortgages and remortgaging, a home reversion scheme is pretty simple in theory. You sell a share of your property to a third party in exchange for an agreed amount of money. As you are quite literally selling part (or all) of your property, there are no repayments as such. However, on the death of the last borrower or if they were to move into long-term care, the property will be sold. At this point the home reversion company receive their share of proceeds.
One of the main issues with home reversion schemes is that you will only be offered between 20% and 60% of the market value of any share of your property. However, during this time, the homeowners will be eligible to live in the property rent-free. These figures will give you an idea of how it works:
Property value: £200,000
Percentage of property sold: 50%
Market value: £100,000
Funds received: Between £20,000 and £60,000
Future property value: £400,000
Home reversion company share: 50%
Home reversion company payment on sale: £200,000
In theory, a home reversion company could turn a £20,000 investment into £200,000. However, this could take 10, 20, 30 years or even more to crystallise. During this period, the funds would be tied up and exposed to the property market.
Pros and cons of a lifetime mortgage
Pros of a lifetime mortgage
There are several advantages to consider when looking at lifetime mortgages which we will now cover:
- Due to the structure of a lifetime mortgage, there is no requirement for an affordability test
- When the interest charge is rolled up, there are no monthly repayments
- Even if interest is paid monthly, there is no element of capital repayment
- Regulations protect borrowers from the unlikely event of negative equity
- No mortgage capital repayment is required until the last borrower dies or moves into long-term care
- Interest rates tend to be competitive due to the relatively low LTV ratio
- The homeowner will still benefit from an increase in the value of their home
The idea of borrowing money against the equity in your property, with no monthly repayments, has obvious attractions. However, there are some disadvantages when using the lifetime mortgage option.
Cons of a lifetime mortgage
There is no such thing as a free lunch when it comes to financing, and there are some disadvantages to consider when looking at a lifetime mortgage:
- The rolled-up element of interest includes interest on interest and can be significant
- A relatively low LTV ratio will restrict the level of equity you can release from your property
- Capital and interest charges may leave no excess equity when the property is eventually sold
- This is an open-ended financial obligation
It is essential to take advice when looking to release equity via the lifetime mortgage route. This is because the expense of interest on interest can be significant over the longer term.
Pros and cons of a home reversion scheme
Pros of a home reversion scheme
While there are certainly some drawbacks with home reversion schemes, there are also some advantages:
- There is an option to sell all or part of your property under a home reversion scheme
- Relatively quick payment when a sale has been agreed
- No repayments
- Right to live rent-free in the property until the last borrower dies or moves into long-term care
- If this is your primary residence, the sale proceeds should be tax-free
- This type of scheme can be used as a means of reducing your inheritance tax bill
- Funds raised could be used to pay off relatively high-interest debt
At first glance, there are several benefits for those looking towards home reversion schemes. No affordability checks, no repayments and in most cases, where it is the primary residence, no tax liability.
Cons of a home reversion scheme
It is essential to be aware of the potential disadvantages of home reversion schemes which include:
- You may only receive between 20% and 60% of the market value
- The release of capital could impact your entitlement to benefits
- A partial or total sale of your property to a home reversion scheme will reduce assets left to your beneficiaries
- You will no longer be the sole owner of the property
- Not all equity release schemes will facilitate a move to a new home
- Early termination of the agreement would force you to buy back the reversion company’s share of your property at full market value
- The borrower must maintain the property in good condition and is liable for all repairs and maintenance
Which equity release options best suit your scenario?
It is advisable to take professional financial advice when looking to release equity from your property. The most appropriate option will depend upon your financial situation and your plans for the future.
Remortgage equity release
The remortgage equity release option is most appropriate for homeowners:
- Looking to leave their home to beneficiaries in the longer term and having sufficient income to cover mortgage payments
- Able to remortgage on lower interest rates with an element of equity release
- Looking to raise capital to pay off high-interest debts using low-interest mortgage funding
- Planning to retain complete control of the property in the longer term
The lifetime mortgage equity release option tends to be more relevant for homeowners:
- Looking to raise capital but with limited income - they would not pass the remortgage affordability test
- Intent on leaving their home as an inheritance – although the element of interest on interest will impact the remaining equity
Home reversion schemes
Thankfully, the Financial Conduct Authority now regulate home reversion schemes, which has injected an element of trust into the sector. This type of equity release tends to be more appropriate for homeowners:-
- Looking to raise capital relatively quickly
- Struggling to cover their living expenses – seeking rent-free accommodation until the last borrower dies or is placed in long term care
Remortgage vs equity release
When considering the release of equity from your home, it is vital to take professional financial advice. All aspects of your personal and financial life should be considered, such as your income, financial needs and your short, medium and long-term plans regarding inheritance and beneficiaries. There may be alternative ways to raise capital, although with mortgage rates relatively low, releasing equity can be a very useful way to pay off high-interest debt.