How to unlock money from your home
Our current economic problems are hitting pensioners hard - in particular new retirees looking to generate an income from their pensions. According to research from Moneyfacts, annuity rates fell by 11.5% last year, leaving many cash-strapped retirees living on much lower incomes than they had originally anticipated.
But with pensioners holding on average £160,000 of equity in their homes, equity release – which enables homeowners to unlock some of the value that has built up in their home – could potentially be the answer to their cashflow problems.
The number of people taking out equity release is growing – the quantity of new plans taken out in 2012 was 6.3% higher than 2011; however, that number is still relatively small at 19,675, according to figures from Key retirement Solutions. it seems many homeowners are either unaware of equity release or unconvinced by it.
"The primary reason more people do not think to use equity release is a lack of knowledge and understanding of how the products work and how equity release could benefit them," says Roger Marsden, head of retirement at Aviva. "Another obstacle is a lack of high-street presence for equity release, despite its potential usefulness, and the fact that consumers are not aware of where to go for these products."
Of course, past mistakes by the sector are also playing their part.
"The term 'equity release' has covered a broad, dissimilar range of products since the 1960s, and i'm afraid the modern plans are tarred with the same brush as those available when the industry was in its infancy," says Steve Wilkie, director of responsible equity release.
"Our research has shown one in three people over 50 believes that equity release involves selling your property. clearly, we still have a lot of work to do in educating consumers."
Choosing the right plan
There are currently two broad types of equity release products available on the market – lifetime mortgages and home reversion plans.
A lifetime mortgage is similar to a regular mortgage, only it does not require monthly repayments. You retain ownership of your property, and repayment of the loan and compound interest is not due until the last mortgage holder either dies or moves into long-term care. there are two choices of how to receive your funds if you take out a lifetime mortgage: either as a lump sum or in smaller, regular amounts, following an initial loan out of an agreed reserve.
A home reversion plan allows you to access all or part of the value of your home while also remaining in your property for the rest of your life. the provider will purchase all or part of your house, considering factors such as your age and health, and will offer a tax-free cash lump sum or regular payments if you prefer, along with a lifetime lease.
At the end of the plan, your property is sold and the proceeds are shared according to the agreement.
Equity release is not without its downsides. "It can cause discord in families if relatives, such as children, don't realise that their parents have used equity release on the family home," explains Nigel Waterson, chair of the equity release council. "All council members encourage customers to speak to their families."
With a lifetime mortgage, the interest the loan each month; if held over a long is added to period, this can add up. So while the person will never owe more than the value of their home, it does reduce the amount of any inheritance left.
And equity release is not available on all properties, such as properties over shops, for example.
One criticism of the equity release market has been that, by its nature, it is a product that targets older people who, in some cases, may be seen as vulnerable. indeed, in the past the sector has had a somewhat murky reputation. However, those companies operating in the market today say much has been done to improve it.
"Two major steps have taken place to offer greater consumer protection," says Dean Mirfin, group director at Key Retirement Solutions. "The first was the establishment of the trade body SHIP, now the Equity Release Council. SHIP established a number of protective measures which all plans had to comply with. The second is that all equity-release plans, and the advisers who sell them, are regulated by the Financial Conduct Authority [formerly the Financial Services Authority]."
Strict code of conduct
Indeed, Waterson says equity release is now one of the most regulated financial products in the UK.
"A person can only take out a plan if they have financial advice from a qualified specialist, and members of the Equity Release Council insist they also receive independent legal advice," he says. "In addition, all council members adhere to a strict code of conduct, which includes safeguards such as a 'no negative equity guarantee' and the right to stay in their property for life."
Still, despite the safety regulations now in place, there is a lot to consider – for example, the impact equity release could have on your state benefits.
According to the Equity Release Council, as a general rule, means-tested benefits such as Pension Credit and Income Support may be impacted, but state pensions or disability benefits such as Disability Living Allowance or Attendance Allowance will not be.
"A professional regulated adviser will take into account all sources of funding including state benefits," says Stephen Lowe, customer insight director at Just Retirement.
"Often this 'fact find' reveals pensioners are not claiming their benefits and doing so may take away the need for equity release. Our figures for 2012 show, for example, 23% of clients were failing to claim any benefit, losing an average of £655 a year, and in the largest case the amount unclaimed was £3,631 a year."
Also bear in mind what will happen should you decide to move house. With equity release, you are able to sell your property and repay the equity release loan, but if you plan on taking the loan with you to your new property you may have problems since there are restrictions on the types of property you can use equity release on.
Impact on inheritance
It's important to consider the impact of equity release on those left behind after your death.
If you have a spouse and you take out equity release on a joint basis, then it is not due for repayment until the second person dies or decides to sell the property. However, if you live with a dependant – such as a child – then you will need to make provision for them in your will and the loan will need to be repaid. Should you die shortly after signing the deal, the property is sold and the money is repaid to the lender by the estate.
"The only potential complication is that if the money has not been spent, it will be counted as part of the estate for inheritance tax purposes, which may mean that it takes longer to repay the loan," says Waterson. "The financial adviser should fully explain the implications to the client".
Perhaps you'd hoped to leave your home as an inheritance to your family but if you are struggling to make ends meet now, it could be a practical solution.
Pros and cons of opting for equity release
- You can enjoy your home for the rest of your life but make use of its value.
- It can top up your pension income in the face of falling annuity rates, or provide a tax-free lump sum.
- A no negative guarantee means you'll never owe more than your home's sale value.
- The amount of inheritance you leave your children could be drastically reduced.
- Because the interest on equity release is compounded (interest is paid not just on the original loan amount but on the loan amount plus accrued interest), it can mount up.
- Equity release is not available on all properties.
An equity release scheme, where the money borrowed against equity in the property (up to a maximum of 50%) is subject to interest charges and although the borrower makes no payments during their lifetime, the monthly interest repayments will roll up and be added to the original debt, which will be settled on the borrower’s death. A lifetime mortgage is distinct from a home reversion scheme in that the lender never owns part of the property. But most lifetime mortgages are sold with a no negative equity guarantee. This means that if the loan is greater than the property’s value it’s a problem for the original lender and not the homeowner.
The circumstances in which a property is worth less than the outstanding mortgage debt secured on it. Although it traps householders in their properties, the Council of Mortgage Lenders (CML) says there is no causal link between negative equity and mortgage repayment problems. At the depth of the last housing market recession in 1993, the CML estimated 1.5 million UK households had negative equity but most homeowners sat tight, continued to pay their mortgages and eventually recovered their equity position.
Tax-free lump sum
An inelegant phrase that is nonetheless accurate in what it describes: a one-off payment to a beneficiary that is free of any form of taxation. Usually received when using a pension fund to purchase an annuity, as 25% of the overall fund can be taken as a tax-free lump sum.
The tax levied on the total value of your estate after you die. IHT has to be paid by the beneficiaries of your estate before they can receive any of the money from it. The money can’t be taken from the value of the estate _– it has to be paid before any money can be released. There is an IHT threshold – known as the “nil-rate band” – below which no tax is levied (£325,000 in 2011/12). Any amount above the nil-rate band is subject to tax at 40%. If your estate totals £600,000, there is no tax on the first £325,000; however your estate will pay 40% tax on the remaining £275,000, a total of £110,000. Prudent tax planning can reduce your IHT liability, so always consult a specialist solicitor.
Everything you own: all your assets (property, cars, investments, savings, insurance payouts, artwork, furniture etc) minus any liabilities (debts, current bills, payments still owed on assets like cars and houses, credit card balances and other outstanding loans). When you’re alive this is called your wealth; when you’re dead, it becomes your estate.
This is effectively paying interest on interest. Interest is calculated not only on the initial sum borrowed (principal) or saved (see APR and AER) but also on the accumulated interest. The more frequently interest is added to the principal, the faster the principal grows and the higher the compound interest will be. Compound interest differs from “simple interest” in that simple interest is calculated solely as a percentage of the principal sum.
A term to describe financial products or ‘plans’ that help older homeowners turn some of the value (equity) of their homes into cash – a lump sum, regular extra income, or sometimes both – and still live in the home. There are two main types of equity release: lifetime mortgages and home reversion plans (see separate entries for both). Whichever type you choose, you borrow money against the value of your property, on which interest is charged, and the loan is repaid when the house is sold after your death.
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.
Home reversion plan
An equity release scheme whereby you sell part or all of your property to a home reversion provider, in exchange for a cash sum or income and you are guaranteed occupancy for life. On your death, the agreed proportion of the proceeds from the house sale reverts back to the provider and the rest is distributed to family. Although you don’t repay the loan until you die and have lifetime occupancy, the cash raised will not reflect the true value of the part of the property sold and you lose the right to any future growth in the part of the property you sold.