What is equity release? Is it right for me?

In these belt-tightening times, many of us are looking for ways to access a little extra cash.

If you’re a homeowner over age 55 and nearing retirement, you might have seen advertisements suggesting that equity release could ease your cash crunch.

Equity release refers to a process that allows homeowners to take value from their home and turn it into a cash lump sum. It involves either taking out a loan against your property or selling a share of your home to your provider. It can help you access (‘release’) the money (‘equity’) tied up in your home.

Is equity release right for you?

Entering into an equity release scheme is not a step to be taken lightly. It’s a major lifetime commitment that has useful upsides for some people, but isn’t right for everyone.

Releasing equity can feel like a quick solution to a tough problem. In truth, it carries a high risk, so it’s probably not a good idea for most people.

Some factors to take into account:

• Your age. Most equity-release programmes have a minimum age of between 55 and 65.
• Your financial situation. What’s your income? Are you entitled to social security benefits? Are family or friends able to help provide support? Do you have other investments or assets?
• The amount of money you’d like to free up. Deciding on the amount you want or need can help determine what kind of equity release is right for you -- or whether there is another way to get to that money.
• Your future plans. Consider what you want out of the next five, 10, 20, or more years. Are you planning to remain in place or do you want the option of moving home?

Is downsizing your home a better option?

Cash-strapped homeowners should also consider other options, including downsizing to a smaller, less expensive home. The homeowner could then live off the proceeds from the sale.

Such a move has additional benefits for people in retirement. For instance, the new property could better suit their present needs -- fewer stairs, for instance, or requiring less upkeep.

If you’re thinking of downsizing, consider doing it sooner rather than later because it could be a critical step on the road to money-saving success.

But downsizing itself carries risks.

For example, the fees incurred in selling your home and buying a new property can be costly.

Additionally, your home might have sentimental value. Moving out of the area could also mean losing touch with your community or feeling cut off from your social support. In those situations, the emotional toll can be high.

If you are thinking of moving house, and want to ensure you’re getting the best value for money from your estate agent, try this comparison tool. It’ll show you the fees, and performance statistics of the best agents in your local area. Head there now.

If you feel like you can’t downsize, consider renting out a room in your home. The government’s ‘Rent a Room’ scheme enables homeowners to earn up to £7,500 per year tax-free.

If you mostly need money to help with home repairs or improvements, check with your local authority, a charity, or a Home Improvement Agency about whether they can assist you at a reasonable cost.

What are the types of equity release?

How much equity you can release from your home depends on many factors, but is typically between 20% and 55% of your home’s value.

There are two types of equity release: a lifetime mortgage or a home reversion scheme. Both allow borrowers to continue living in their home.

Lifetime mortgages allow homeowners to borrow money against their home.

Home reversion schemes call for homeowners to sell a share of their property.

What are their advantages and disadvantages?

A lifetime mortgage is the most common type of equity release for people over 55. It’s a tax-free loan secured against the property, but it doesn’t usually need to be repaid until the last living borrower dies or sells the home. But because the interest ‘rolls up’ (the unpaid interest is added to the loan), the debt rises quickly.

There are two types of lifetime mortgages: a lump-sum, or drawdown (or ‘flexible’) lifetime mortgage.

As its name suggests, with a lump-sum lifetime mortgage the borrower gets a one-off payment at a fixed interest rate. No repayments are required until the borrower dies or moves into long-term care. It’s helpful if borrowers need cash in a hurry, all at once.

Some of the advantages of a lump-sum lifetime mortgage include: lower interest rates, fixed rate for life, and no monthly repayments,

With a drawdown lifetime mortgage, borrowers retain the flexibility to release cash when they need it, rather than in a single lump sum. It’s useful if you don’t need all those funds at once but would rather reserve the option of dipping into your equity as needs arise.

Some of the advantages of a drawdown lifetime mortgage include: lower cost over time, flexible access, and the variable interest rate means that you could end up with lower rates on later withdrawals compared to the initial release (of course, the opposite could be true, too).

Both types of lifetime mortgages enable you to set aside an inheritance for your family by ‘ring-fencing’ some of the value of your property.

Home reversion schemes are also tax-free but are far less common than lifetime mortgages. Most require participants to be over 65.

Home reversions aren’t actually loans, so there isn’t interest to pay. Instead, homeowners sell a portion of their home to the equity release provider and receive a lump cash sum in return. The property usually won’t be sold until the last living borrower dies or enters a permanent long-term care facility. At that stage, the home reversion provider gets a share of the sale.

Advantages of home reversion include: the value of your share will continue to rise if the overall home value increases and there isn’t any interest to pay,

How much will equity release cost me?

Equity release can be expensive, especially when compared to a conventional mortgage.

For instance, lifetime mortgages can cost triple what you borrow after 20 years. And it’s not uncommon for home reversion schemes to offer just a 20% advance on up to 70% of a home’s value.

Additionally, home reversion schemes won’t usually come close to giving you market value for your property compared to selling your home on the open market.

Equity release plans are also expensive to unwind should you want to cancel your plan early or if the homeowner dies shortly after taking out the plan.

Remember: If you release equity on your home, you will not only affect your present circumstances but your future ones as well.

The bottom line

Equity release can be the right decision for some homeowners, but it isn’t something to be entered into lightly. It can sometimes serve as a short-term solution to a long-term problem, so it has many risks.

As with any significant financial decision, if you’re considering equity release seek advice from an independent financial adviser. Be sure that any adviser you choose is on the Financial Conduct Authority register and is a member of the Equity Release Council.