| Brief Guide to Equity Release |
| Equity Release |
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If you are a homeowner in Britain, the chances are that your house or flat is worth at least £150,000. That's a major asset, but you can't get your hands on that money unless you sell your home. You can, however, borrow a relatively large sum of money by taking out, or extending, a mortgage on your home. This is known as 'equity release' or 'equity release remortgaging' - sometimes more loosely referred to simply as 'remortgaging'. (For a more general article about remortgaging, or switching your mortgage provider, see our guide to remortgaging.
Because mortgage interest rates are among the lowest lending rates available, equity release can be the cheapest way to borrow money. If you borrow £20,000 on a credit card, you are likely to be paying 17% interest; as a bank loan, perhaps 8% - but the interest rate on a mortgage could be as low as 4.2%. |
| Why consider equity release? |
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There are many reasons why you might want to borrow a fairly large sum of money. You may wish to install a new kitchen, or build an extension to your house. Perhaps you need capital to fund a new business venture. Perhaps you want to buy a new car or a boat, or take a once-in-a-lifetime holiday.
Or perhaps you just want to get your finances in order. If you have run up large debts at high interest on your credit cards, and there is little prospect of paying them off quickly, now may be the time to bite the bullet and 'consolidate' your debts. You could use equity release to take a loan with which to pay off the credit card debts, and then pay off this loan to a structured schedule at a far lower interest rate. |
| What is equity? |
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Equity is the portion of the value of your house that you actually own yourself. If you have a house worth £200,000, and you have a £75,000 mortgage, you actually own £125,000 of the total value of the house (the mortgage company owns the rest). This £125,000 is your equity.
By extending your mortgage, you will be 'releasing' some of this equity in the form of a loan. So if you extended your mortgage by £20,000, you would be making use of £20,000 of your equity. Then, on your £200,000-home, you would still own £105,000 of its value (equity), and the mortgage company would now own £95,000. Mortgage interest rates are low because mortgage loans are pretty secure: the mortgage company has the value your house for security. If you fail to maintain your payments, the mortgage company can demand full repayment of the entire loan. In the worst-case scenario, this may mean that you will be forced to sell your house to pay off the mortgage loan - a nightmare process known as 'repossession'. The interest rates reflect the basic rule of borrowing. A mortgage is a secured debt, so a safe bet for the lender; hence interest rates are low. Credit card debts are unsecured, so the interest rates are far higher, to compensate for the risk of borrowers defaulting. |
| Types of mortgage loan |
| Equity release can come in virtually all the forms that mortgages appear in: variable (the interest rate fluctuates more or less in parallel with the bank base rate); fixed-rate (the interest rate is set at a fixed rate for a given number of years); capped-rate (the interest rate will move up and down, following the bank rate, but will never exceed a given figure). The way you pay back the loan may be straight repayment (monthly payments of a portion of the loan, plus interest), or interest-only (only the interest is paid during the term of the loan, and then the full loan is paid off at maturity, usually through a scheme such as an ISA or endowment policy). To calculate the relative costs of a mortgage, see our mortgage calculator. |
| Restrictions |
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The total amount you can borrow from a mortgage lender to buy a house or flat depends on your ability to pay back the loan. Calculations are usually based on your income. In the past, a couple could borrow up to three times the main income-earner's salary plus the second income-earner's salary (3 + 1), or 2.5 times both incomes. In these days of relatively high property values, the limits have become more flexible, rising to as much as 5 + 1.
Similar restrictions are applied to loans based on equity release. Mortgage companies will want to be assured that you are able to pay back the extended loan, according to the repayment schedule agreed. However, if the loan is low relative to the total value of the house, mortgage lenders are likely to be more generous, because the total value of your house gives them a wide margin of security. All you may need is 'self-certification': a declaration (without proof) that your income is sufficient to cover the cost of servicing the loan. |
| Overborrowing |
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With the exception of a few rogue years, house prices in the UK have been climbing relentlessly since the 1960s. Houses that cost £25,000 in 1980 may now be worth ten times as much. This means that there is an enormous amount of equity around. In recent decades, many homeowners have been making advantage of this rise in their net worth by extending their mortgages. And many have been using equity release to fund a lifestyle they can't really afford.
Various financial authorities have criticised the mortgage lenders for being too lenient with borrowers - allowing them to borrow more than their incomes justify. Equity release has helped to fuel the 'borrow-now, pay-later' culture that has given Britain record levels of personal debt. Extending your mortgage may be a cheap way to borrow money - but a loan is a loan. It has got to be paid back some time. If you are using equity release to service unsecured debts (e.g. credit card debts), this only makes sense if you can stop running up further unsecured debts in the future. Otherwise, you will just be digging a deeper hole, and effectively securing unsecured debt, to your peril. Remember: if you have a mortgage that you cannot service, you may face repossession and end up losing your home. |
| Equity release schemes for older homeowners |
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Older homeowners (usually aged over 65) who have paid off their mortgage can release some of the equity tied up in their home by taking out a 'lifetime mortgage'. This means taking out a loan secured against the value of the property; the loan and interest is paid back when the homeowner sells (for instance, to move into a retirement home), or dies.
Under 'home reversion plans', the scheme is somewhat different. The homeowner sells a fixed percentage of the value of the house to a lending company (or an individual) for an agreed sum. The company can then redeem its stake in the house when the homeowner sells, or dies. The money raised by releasing this equity can be paid to the homeowner in the form of a lump sum, or as regular income. Such schemes permit older householders to stay in their homes when the alternative might be to move in order to raise spending money. The Home Improvement Trust is a not-for-profit organisation that arranges equity release for older homeowners and the disabled to permit them to make home improvements or adapt their homes: www.hitrust.co.uk There are caveats. Some of these schemes can be costly to set up; and home reversion plans tend not to reflect the true market value of the property - at the time the contract is negotiated, and especially after the elapse of several years during which house values have risen. Lastly, older homeowners who use an equity release scheme will of course reduce the value of the assets that they can pass on to their heirs. For advice, consult Age Concern at www.ageconcern.org.uk |
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