2023 update:
What are the Pitfalls of Equity Release?

Introduction

Too often seniors jump at the opportunity to release their equity without asking themselves, “What are the risks?”

Below, we’ve taken the time to detail the pitfalls of equity release schemes, so you can make an informed financial decision.

 

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What is equity release?

Equity release is a broad term that refers to a range of products that allows individuals to access the equity locked in their home.

The tool permits people to borrow against their home without having to move or attempt to sell their home quickly.

There are two primary options for equity release in the UK:

Lifetime mortgage

• In this case, individuals can take out a mortgage secured on the property while still retaining ownership of the home.
• The one main condition for this is that the house must serve as the individual’s primary residence.
• Typically, this is the most common form of equity release in the UK.
• When the individual dies, the home sells in probate, with the proceeds going toward the mortgage payment.
• This would also happen if the individual moved into long-term residential care.
• Borrowers have the option of making payments on the mortgage or allowing interest payments to collect as part of the lump-sum debt.

Home reversion

• In this case, homeowners can sell their home while they continue to live it in until they pass away or move to a long-term care facility.
• Residents do not necessarily have to sell the entire house. They have the option of selling only part of the home. Typically, residents will sell to a reversion provider.
• The reversion provider will provide the homeowner with either lump sum or periodic payments.
• Even though homeowners sell to a provider, they do not have to pay rent to continue living in the home. However, they are responsible for maintaining and insuring the house, meaning they cannot let the home fall by the wayside.
• Homeowners also have the option of utilising a tactic called ‘ring-fencing’.
• In this case, homeowners can secure part of the property for inheritance while selling the rest.
• For instance, imagine a homeowner lives on substantial land and wants to pass along this land to his or her children while still borrowing against the home. This would be a situation in which ‘ring-fencing’ would be sufficient.

Who qualifies for equity release?

Not everyone is eligible for equity release. There are criteria homeowners must meet to qualify.

For instance:

• Those interested in a lifetime mortgage must be at least 55 years old.
• Those interested in a home reversion plan must be at least 65 years old.
• This goes for all parties involved. If borrowing jointly, everyone must be of age.
• Furthermore, those interested in equity release must live in the United Kingdom and the home in which they seek to take out equity relief must be their primary residence.
• Those who own foreign property cannot declare this home as their primary residence, which some people often do as a way to avoid capital gains taxes.
• If homeowners own a foreign property against which they would like to borrow, they are subject to local laws and regulations.
• This can vary from country to country. Thus, it’s essential to remember that only properties in the UK are eligible for equity relief.
• Additionally, the property must be in reasonable condition and over a minimum value.

Mortgaged property

Just because you already have a mortgage or secured loan on the property does not preclude you from apply for equity release.

You will just have to pay off the debt at the time the equity release scheme is entered.

Dependents

Lastly, although it’s not a hard-requirement, homeowners should put careful consideration into equity relief if they have dependents living with them.

That’s because the equity release only protects the homeowners.

Once homeowners pass away or move to a long-care facility, the dependents are no longer allowed to live in the home.

This is one of the pitfalls of equity release. If you are a tenant or dependent who lives in a house where the owners are considering equity release, we advise you to seek separate legal counsel.

A solicitor can better assess your situation and determine if you should continue to live in the home.

Dependents may need to sign a waiver indicating they understand that their time in the house is limited.

The rise of equity release schemes

Equity release has become more and more popular over the past few years. Common reasons include:

• Live a more comfortable lifestyle in retirement.
• Take a dream vacation or holiday.
• Purchase a vacation home.
• Renovating the existing house or outdoor area.
• Gifting early inheritance to children and grandchildren.
• Clear debt or mortgage.
• Padding the monthly retirement income.
• An alternative to downsizing

Equity release is growing in the United Kingdom at an alarming rate. According to the Equity Release Council, seniors released more than 3.06 billion pounds’ worth of equity from their homes in 2017.

Although some of this was thanks to those who had released equity previously, a majority came from the 37,000 new customers who signed up last year.

The Council said that new customers agreed to an average initial instalment of 62,539 pounds in the final quarter.

• This was an increase in more than 2,500 pounds from the prior three months in the previous year.
• The average drawdown for returning customers in the last quarter was nearly 11,000 pounds.
• The average total lending amount topped 72,200 pounds.

While we’re still waiting for the final figures for 2018, initial estimates showed that equity release was continuing to grow in popularity. For instance, Responsible Life, an equity-relief specialist, indicated that the total amount of equity released by homeowners rose by nearly six percent between April and May of this year.

Perhaps one of the most significant draws is the fact that lenders provide a no-negative equity guarantee. This means that those borrowing against the value of their home will never owe more than the total amount of the property.

Responsible Life managing director Steve Wilkie provided insight as to why more and more people utilise equity relief…

Wilkie said, “With interest rates on savings accounts still in the gutter, drawdown lifetime mortgages are providing a vital retirement income lifeline. They are filling the savings void and also enabling pensioners to keep pension savings invested.”

So, instead of living on properly-allocated retirement savings, people are instead living lavish lifestyles by taking on debt in their later years.

Top 3 pitfalls of equity release

Unfortunately, too many seniors in the UK seek to live extravagant retirement lifestyles without thinking about the long-term implications of their decisions.

It’s vital that homeowners take the time to investigate the dangers of equity release before making their decision. Below, are some of the most common pitfalls of equity release that homeowners fail to consider.

Loss of benefits

One of the most common equity release horror stories we hear is that seniors don’t realise just how much the program can harm their state benefits. In the UK, the government evaluates the need for state benefits based on capital and income. If you have low to moderate income while retired, the government will likely determine you need state benefits.

However, when utilising equity relief, homeowners unlock cash from their home, either in the form of a lump sum or portioned payouts.

Regardless, the homeowner’s monthly income skyrockets with the influx of capital, causing many homeowners to breach the limits of means-tested benefits, causing them to lose out on many entitlement programs, including council tax reduction and pension credits.

No-negative equity

Many view no-negative equity as a huge perk of the equity release program. However, pretty much all lenders give this guarantee, even if the ERC does not back them.

The ERC ensures equity release programs, so homeowners should be wary of working with lenders who the organisation does not support, even if it means forgoing the best rate.

Taking out more money than necessary

Another common pitfall is that homeowners choose to take out more money than they need. Homeowners do this because they wish to enjoy retirement to the max.

However, seniors should only use the equity release program on a need-basis. Homeowners should take money from their home that they can spend and potentially repay.

If homeowners need to secure more capital in the future, they can always secure another loan as a part of the equity release program. But since all loans will eventually be repaid with interest, withdrawing cash to sit on it is nothing but a waste of money.

Interest roll-up can become particularly expensive, especially if the lump sum that the homeowner withdrew is substantial.

Getting advice

The best advice that we can give is not to make a rushed decision.

Homeowners must consider the fact that they likely will not be capable of repaying another mortgage before they die, so any amount left unpaid will be subtracted during the sale of the home, which could take away from inheritance amounts left to children and grandchildren.

Homeowners should think of both the long-term and short-term implications of equity relief.

We recommend homeowners find a whole of market independent financial advisor who can detail the dangers of equity release and evaluate whether this strategy is the best for your personal circumstances.

Useful links:

• Financial conduct authority register
• Equity release council members