The idea of releasing equity in your property is relatively straightforward, but there are several issues to be aware of in practice. These issues become a little more challenging for the over 50s, but this has prompted the creation of new equity release products and new markets. As some of the options are a little more complicated than a traditional remortgage, it is essential to speak with an equity release adviser as soon as possible.
What is equity release?
In simple terms, equity release is a means of retaining ownership of your own home but releasing some your home's value (the equity) that has built up over the years. While the traditional method would be a remortgage, based on the value of your home, this is not always possible for those over 50 and possibly experiencing a reduction in their income. There is now the option of a lifetime mortgage or a home reversion scheme whereby capital is raised in different ways but not paid off until death or a move into full-time care.
There are many equity release calculators available online that will give you an indication of what may be available. However, these will be subject to your financial status. You will need to approach an equity release provider for a personalised illustration.
Popular reasons for equity release
Many people view equity in their homes as underperforming funds because, at best, they will follow house prices. Consequently, as funds perhaps become a little tighter, it can be tempting to release an element of equity from your home. The most popular reasons for equity release include:
Garden and home improvements
A recent survey confirmed that 30% of those looking to release equity from their property did so to fund home/garden improvements. In theory, an investment in home/garden improvements should add value to the property in the longer term. However, it is crucial to take advice from local estate agents. Many areas of the UK have a property "price ceiling", which effectively caps house prices in the area. Consequently, there might be occasions where the cost of your improvements isn’t reflected in the enhanced property value.
New property purchase
As a so-called "baby boomers", born between 1946 and 1964, have you benefited from a massive increase in the value of your property? Consequently, when approaching/in retirement, there may be an option to release equity from your main residence and use funds to acquire another property or even a holiday home. While there are risks with further property investment, the release of equity can create a helpful income stream with the potential for long-term capital appreciation.
When acquiring additional properties, it may be useful to take advice regarding potential inheritance tax issues further down the line.
Release tax-free cash to pay off mortgage or other debts
It may seem a little bizarre to release equity in your property to pay off your mortgage; how does that work? Well, with a lifetime mortgage, you can remortgage part of your property with interest rolled up and repaid to the lender, together with the mortgage capital, upon death or a move into long-term care.
Many people also consider equity release to pay off additional debt such as credit cards, personal loans, etc. While the idea of tidying up your finances can reduce long-term financial pressure, it is even more effective with high-interest finance. For example, let's say you have credit card debts with an interest rate of over 20% per year. By releasing equity, which will only track property prices at best, you're effectively saving 20% per annum less the remortgaging/lifetime mortgage cost. Potentially an advantageous way to use the equity in your property!
Increase disposable income
The only time that equity would be released is upon their death for many people. In many ways, those who have saved up to pay for their home, creating significant equity, will never feel the benefit. However, things are changing!
The vast majority of those over 50 will begin to experience a degree of reduced income from employment. While some of this will be replaced by pension income, overall, it is not uncommon to experience a decline in disposable income. Therefore, releasing equity in your property, as a lump sum or bit by bit, can help to shore up your disposable income and improve your standard of living. This subject is even more crucial when considering the recent increase in energy costs which will significantly impact many household budgets.
Helping family members
Inheritance tax planning should be an integral part of your annual financial review, especially as you move towards retirement and beyond. In many ways, the inheritance system is flawed; beneficiaries receive funds after your death which may have been more helpful in their early years. In addition, many of those approaching retirement may be looking at assisting with further education costs for children and great-grandchildren.
This can be an incredibly complex area of taxation because there are various "gifts" you can make to loved ones without incurring tax. Alternatively, significant payments to family members may attract inheritance tax further down the line. So don't forget to take advice!
As you approach retirement age, you may be eligible for a significant tax-free lump sum from your pension scheme. After years of working, saving into your pension, many people will treat themselves to a one-off purchase such as a new car or that dream holiday. There are no tax complications with this option, simply withdraw your tax refunds and spend them!
Are there any age limits on equity release?
As you can see below, apart from 2019 and 2020, there has been a gradual increase in the everyday working life. This trend is likely to take another upward surge due to changes to the UK pension age. When you also consider the ever-growing cost of living, many people in their 50s will be working full-time to maintain, let alone enhance their standard of living.
As a consequence of this upward trend in the duration of your working life, more people over 50 will have employment income streams and potentially pensions/investment income. For many, employment income will reduce with age, but a traditional remortgage could still be available for those in their 50s, 60s, 70s and even 80s. When looking at lifetime mortgages and home reversion schemes, which we will cover in more detail later in this article, there is a minimum age limit 0ff 55.
On the subject of age, it is essential to note that it is illegal to discriminate against anyone on the grounds of age alone. A traditional remortgage should be based on your financial situation and not your age. When it comes to a lifetime mortgage, the older you are, the more equity you can release because of the reduced impact of interest on interest. A home reversion scheme has no age limit as you are selling part of your property to an investor.
The ongoing strength of the so-called "grey pound" has created an array of new services and financial tools for those in their mid-50s and older. The UK is an ageing population; working lives are being extended, and traditional age cut-off points have been redrawn. Amidst a sea of options and opportunities, it is imperative that you take financial advice at the earliest opportunity. There is a lot to think about!
How much can you raise through equity release?
The precise level of equity you can release from your property will vary according to your financial situation. With this in mind, it is crucial to appreciate the vast increase in house prices over the years. The following graph shows the Nationwide House Price Index going back to 1952. The average home was valued at £1891, but if we fast forward to the end of 2021, the average value was £253,113. It is safe to say that the "baby boomers" have done well but what of other age groups?
Source: Nationwide House Price Index
Assuming that the average mortgage duration is 25 years, those who acquired their home before 1997 may have paid off their mortgage. In reality, they may have remortgaged and moved home numerous times, often building up equity along the way. The average house price in the UK at the end of 1996 was £55,159. Compare this to the price at the end of 2021 (£253,113), which equates to house price growth of 350%.
Looking at the loan to value (LTV) ratio, a traditional mortgage could be anything up to 80%, a lifetime mortgage between 45% and 58% with no formal limit for a home reversion scheme.
What is a mortgage affordability test?
In the aftermath of the 2007/8 financial crisis, brought on by a collapse in the US mortgage industry, governments and regulators worldwide introduced mortgage affordability tests. This made perfect sense at the time, with companies such as the now failed Northern Rock offering mortgages over 100% of a property’s value. The concept behind the test was simple, consider income/living expenses and calculate whether a client could afford to maintain mortgage repayments now and in the event of future interest rate rises. But is this a fair system?
In theory, it made perfect sense to restrict what became known as “casino “financing. However, we are now in the bizarre situation where homeowners fully able to cover their mortgages don’t qualify to remortgage. They fail the mortgage eligibility test and miss out on potentially considerable interest payment savings. While regulators have recently entered the fray to resolve the situation, it is challenging to say the least.
If a mortgage arrangement involves regular repayments such as a traditional mortgage and a remortgage, this will fall under the remit of the mortgage affordability test. However, when it comes to the lifetime mortgage and home reversion schemes, there are no monthly repayments, and therefore this is outside the scope of the mortgage affordability test. Consequently, the latter two arrangements are proving extremely attractive for those over 50, looking to release equity from their home.
Different types of equity release
We will now look at equity release mortgage options for those over 50. Indeed, lifetime mortgages and home reversion schemes are structured explicitly for those over 50 years of age. So what are the alternatives?
Unfortunately, if an individual or a couple are experiencing a reduction in their income in later life, this will impact their ability to refinance an existing mortgage. At best, this will reduce the LTV ratio and at worst, they could fall foul of the mortgage affordability test. As we touched on above, due to changing working life trends and a greater appreciation of borrowers over the age of 50, there are greater opportunities today than ever before. However, each case is different!
Some people working later in life may maintain a relatively high income and therefore potentially afford LTV ratios up to 80%. However, in reality, the vast majority of those looking to release equity will be looking for a far lower figure.
On a side note, check there are no early repayment charges when looking at an equity release plan.
- No age discrimination
- Calculation based on income alone
- Some may fail the mortgage affordability test
- LTV ratio may be reduced
The lifetime mortgage option for those looking to release equity is a hybrid of a traditional remortgage. There is still a headline interest rate, interest repayments, and capital repayment at the end of the arrangement. However, when looking at the details, it is essential to remember:
- Interest is rolled up and repaid together with capital
- There are no monthly repayments
- Lifetime mortgages are not within the scope of the mortgage affordability test
- There is a drawdown option to take funds when required rather than in one lump sum
- Initial loan amount and interest is repaid when the property is sold
- Property is sold on death or a move into full-time care
It is safe to say that interest in lifetime mortgages has increased dramatically in recent years. Historically, there was an interest-rate premium on lifetime mortgages compared to traditional remortgages. However, this premium has reduced as competition increased with scope for more short, medium, and long-term reductions.
Due to the element of interest on interest and the risk that property prices may not rise in the longer term, the traditional LTV ratio on a lifetime mortgage is between 45% and 58%. The older the homeowner, the higher the LTV ratio because:
- The investment duration risk is reduced
- The impact of interest on interest will fall
On the surface, this may tick many boxes for those not eligible for a traditional remortgage. However, you need to appreciate the impact of interest on interest over a prolonged period. You may be paying interest on interest for 20, 30 or even more years. The duration of a lifetime mortgage is based upon the death of the homeowner/move into full-time care.
Upon receipt of sale proceeds, the mortgage capital and rolled up interest would be paid off with the balance passed to the homeowner/their estate. Under new regulations, the lifetime mortgage company would not pursue the homeowner/their estate for additional funds in the event of negative equity.
- No monthly payments mean no mortgage affordability test
- Positive impact on cash flow
- No negative equity guarantee
- Interest rates tend to be higher than those for traditional mortgages
- You will pay interest on the rolled-up interest
Home reversion scheme
Unfortunately, before recent changes and the introduction of formal financial services regulations, the home reversion scheme sector attracted more than its fair share of negative headlines. However, the concept is simple when looking to release equity from your property; it involves a part sale of your home to an investor. So far, so good.
One of the main problems is that you will only receive a fraction of the market value from the investor. In theory, if you sold a 50% share of a £200,000 home, you would expect to receive £100,000. In practice, with a home reversion scheme, you would receive anywhere between £20,000 and £60,000 for a 50% share of your home, a significant discount to the market value. There are several issues to consider, such as:
- The homeowner will live rent-free for the rest of their life/until they move into care
- No repayments with a home reversion scheme
- Duration of arrangement is open-ended, dependent upon death/move into care
- Rent-free accommodation
To qualify for a lifetime mortgage, you need to be over 50 years of age and own your home with an element of equity. When the property is eventually sold, the net proceeds will be shared out between the homeowner (their estate) and the home reversion scheme investor on a pro-rata basis.
- No repayments
- You will live rent free for the rest of your life or until you move into care
- Potential long-term benefit from house price growth
- Investor will pay significant discount to market price
- Future movement to a new property may be restricted
Is equity release regulated?
Up until recently, both lifetime mortgages and home reversion schemes weren’t regulated by the Financial Conduct Authority (FCA). Thankfully, they now come under the remit of the FCA and are fully regulated in England, Scotland, Wales and Northern Ireland. This enhanced regulatory scrutiny should improve the quality of service providers and service to customers. It also ensures that those with a problem or complaint can directly approach the regulator. Many of those companies offering equity release products will also be a member of the Equity Release Council, the private equity industry's trade body.
Enhanced choice of equity release
While the introduction of mortgage affordability tests significantly impacted mortgages and remortgages for the over 50s, lifetime mortgages and home reversion schemes are valuable alternatives. Historically, those over 50 would struggle to secure a traditional remortgage, but there has seen significant change.
Whether you are considering a remortgage, lifetime mortgage or home reversion plan, it is vital that you take equity release advice from a professional financial adviser. There are various pros and cons to consider in line with your specific financial situation.