How does equity release work?

Whether you’re considering equity release for yourself or just want to learn more about this unique financial product, you’ve come to the right place.

Equity Release Explained

Equity release is a type of financial product that allows homeowners over the age of 55 to access the equity (i.e. the value) tied up in their property without having to sell it or move out. Instead, the homeowner can take out a loan against the value of their property, either in a lump sum or in smaller amounts over time, and typically with the understanding that the loan will be repaid through the sale of the property after the homeowner has passed away or moved into long-term care.

How Much Equity Can You Release?

The amount of equity that can be released depends on a number of factors, including the age and health of the homeowner, the value of the property, and the type of equity release plan chosen. There are two main types of equity release plans: lifetime mortgages and home reversion plans.

Lifetime Mortgages

With a lifetime mortgage, the homeowner takes out a loan against the value of their property, with interest charged on the outstanding loan balance. The loan is repaid through the sale of the property after the homeowner has passed away or moved into long-term care. The interest can be paid off as it accrues, or allowed to roll up and be added to the outstanding loan balance.

Lifetime mortgages explained

Home Reversion Plans

With a home reversion plan, the homeowner sells a portion of their property to the equity release provider in exchange for a lump sum or regular payments. The homeowner retains the right to live in the property rent-free, but upon their death or move into long-term care, the equity release provider will receive a portion of the proceeds from the sale of the property proportional to the share they own.

Home reversion explained

We have a free equity release calculator for you to use. It will give you a good indication of the amount of equity you can release from your home, based on your age and the value of your home. Plus, you do not need any of your personal details to use it.

If you want to find the best equity release deal then having an idea of how much you can release is a good starting point.

Equity Release Eligibility Criteria Explained

Minimum Age

The minimum age for equity release is typically 55 in the UK, although some providers may require you to be older. There are a few reasons why the minimum age is set at 55:

1. Life expectancy: Equity release products are designed to provide income or a lump sum in exchange for the equity in your property. Equity release providers take on a risk by lending you money, and the longer you are expected to live, the greater the risk to the provider. By setting the minimum age at 55, providers can limit their risk by ensuring that borrowers are unlikely to live for decades after taking out the product.
2. Property value: Equity release products are also linked to the value of your property. As you get older, your property is likely to increase in value, which means there is more equity to release. Setting the minimum age at 55 allows providers to tap into the equity in your property when it is at a relatively high value.
3. Financial needs: Many people over the age of 55 are retired or approaching retirement, and may have limited income or savings. Equity release can be a way to supplement retirement income or pay for unexpected expenses, such as home repairs or medical bills.

Minimum Property Value

The minimum property value for equity release products is typically set at £75,000 in the UK, although some providers may have different minimums. Here are a few reasons why the minimum property value is set at this level:

1. Risk management: Equity release providers take on a risk by lending you money against the value of your property. The minimum property value helps to ensure that the amount you borrow is in proportion to the value of your property. By setting a minimum value, providers can limit their risk and ensure that the loan-to-value ratio is within acceptable limits.
2. Cost-effectiveness: Equity release products can be expensive to set up, with legal fees, valuation fees, and other costs. By setting a minimum property value, providers can ensure that the potential profits from the loan are sufficient to cover the costs of setting up and administering the product.
3. Market demand: The minimum property value for equity release products is also influenced by market demand. There may be less demand for equity release products among people with lower-value properties, as they may have other options for accessing funds or may not want to risk their property. By setting a minimum value, providers can focus on borrowers who are more likely to be interested in the product.

It’s worth noting that the minimum property value is not set by law, and providers can choose to set their own minimums. Some providers may have higher or lower minimums depending on their risk appetite, market demand, and other factors. However, £75,000 is a common minimum property value threshold for equity release products in the UK.

Why Does The Property Have To Be Your Main Residence?

The property in equity release must be the main residence for a few reasons:

1. Security for the lender: Equity release is a type of secured loan, which means that the loan is secured against the value of your property. By requiring the property to be the main residence, lenders can ensure that the property is a stable and secure asset that is unlikely to decrease significantly in value. This provides security for the lender, as they are less likely to lose money if the borrower defaults on the loan.
2. Eligibility: Equity release is typically designed for people who are retired or approaching retirement and who have significant equity in their home but limited income or savings. Requiring the property to be the main residence helps to ensure that the borrower has a stable and secure place to live. If the property were not the main residence, the borrower might be less likely to have a strong attachment to the property or may not be able to afford to maintain it.
3. Tax implications: In the UK, the main residence is typically exempt from capital gains tax when it is sold. By requiring the property to be the main residence, equity release providers can avoid potential tax issues that may arise if the property were used for other purposes, such as rental income or as a second home.

It’s worth noting that the property must also meet certain other criteria to be eligible for equity release, such as being in good condition and not having any outstanding mortgage or other liens against it. These requirements help to ensure that the property is a suitable asset for securing the loan and that the borrower is able to receive the full amount of the equity release funds.

Property Suitability:

Your property must also be suitable for equity release, which means it should be in a good state of repair, located in an area with a strong housing market, and have no significant restrictions or covenants on the title.

How Is Equity Release Paid Back?

The loan amount, plus interest, is typically repaid when you die or move into long-term care. If you opt for a lifetime mortgage, the loan is typically repaid through the sale of your property. With a home reversion plan, the provider takes a share of the property when it is sold.

How Much Does Equity Release Cost

Equity Release Costs Explained

Equity release products can be expensive, with interest rates that can compound over time. You should expect to pay arrangement fees, valuation fees, legal fees, and other costs associated with the product. Try our compound interest calculator.

Setting up an equity release plan involves several costs, including the following:

1. Valuation fees: A valuation fee is the cost of having your property valued by a professional surveyor. The valuation is used to determine the current market value of your property and the maximum amount of equity you can release. The cost of the valuation fee will depend on the size and location of your property, but it typically ranges from £200 to £600.
2. Application fees: Some equity release providers charge an application fee to cover the cost of processing your application. This fee can range from £0 to £995, depending on the provider.
3. Legal fees: You will need to hire a solicitor to help you with the legal aspects of setting up an equity release plan. The solicitor will review the terms of the agreement, ensure that you understand the risks and benefits of the product, and provide legal advice. The cost of legal fees can vary, but according to our research the average legal fees for an equity release solicitor are £1,058 including VAT depending on the case.
4. Adviser fees: You may also need to pay fees to an independent financial adviser (IFA) who can help you understand your options and choose the right equity release plan for your needs. An IFA will typically charge a fee of between £1,000 and £2,500.
5. Interest charges: Like any loan, an equity release plan involves interest charges that accrue over time. The interest rate on an equity release plan is typically higher than on a standard mortgage, as the lender is taking on more risk by lending against the value of your property. The interest charges will depend on the type of equity release plan you choose and the interest rate offered by the provider.

Let’s say you decide to take out an equity release plan for £100,000 at an annual interest rate of 5%. With most equity release plans, you have the option to pay off the interest as it accrues, or you can allow it to roll up and be added to the outstanding loan balance. For the sake of simplicity, let’s assume that you choose the latter option and do not make any interest payments.

After one year, the outstanding loan balance will be £105,000, comprised of the original loan amount of £100,000 plus £5,000 in interest charges. If the interest rate remains the same, after two years, the outstanding loan balance will be £110,250 (£100,000 + £5,000 in interest charges from year one + £5,250 in interest charges from year two), and after five years, it will be £127,628 (£100,000 + £26,628 in interest charges).

It’s important to note that because interest is compounded (i.e. charged on top of previously accrued interest), the outstanding loan balance can grow quite quickly over time, particularly if you are not making any interest payments. This means that the amount of equity you have in your property may decrease over time, as the loan balance increases and the value of your property remains constant or decreases.

However, Equity Release Council member providers should offer a fixed interest rate, which means that the interest rate is locked in for the duration of the loan. This can provide a degree of certainty and predictability when it comes to the outstanding loan balance, but may come with higher fees or other costs. As with any financial product, it’s important to carefully review the terms and conditions of any equity release plan you’re considering, including the interest rate and associated costs.

It’s important to note that some providers may offer incentives or cashback to help offset some of these costs. However, these benefits may come with a higher interest rate or other costs, so it’s important to consider all of the costs and benefits of an equity release plan before making a decision.

Equity release interest rates explained

Risks

Equity release can have a number of risks, including the potential for the loan amount to grow quickly, reducing the equity in your property, and leaving less for your heirs. You should consider the long-term implications of equity release and whether it is the right option for your needs.

The No Negative Equity Guarantee Explained

The ‘no negative equity guarantee‘ is a feature of some equity release plans that provides an important level of protection for borrowers. Essentially, it means that you (or your estate) will never owe more than the value of your property, even if the outstanding loan balance exceeds the value of the property at the time of sale.

In other words, if you take out an equity release plan with a ‘no negative equity guarantee’ and the value of your property decreases, you (or your estate) will not be responsible for paying back the difference between the loan balance and the value of the property. The equity release provider will absorb this loss.

For example, let’s say you take out an equity release plan for £100,000, secured against a property valued at £300,000. Several years later, the property value has decreased to £250,000 and you decide to sell the property. At the time of sale, the outstanding loan balance is £150,000. With a ‘no negative equity guarantee,’ you (or your estate) would only be responsible for paying back the value of the property (£250,000), and the equity release provider would absorb the remaining loss of £100,000.

Conclusion

Overall, equity release can be a complex financial product that requires careful consideration and professional advice. It’s important to understand the costs and risks involved, and to consider alternative options before deciding whether equity release is right for you.