Rising house prices are a double-edged sword for many families. Older generations have seen the value of their homes rise while their children and grandchildren struggle to get onto the property ladder. Now, in order to help their children buy a home of their own, many parents are dipping into the equity of their property.
Equity release, a way for over-55s to get cash out of their property without the need to move home, is becoming more mainstream, with an increasing number of deals and lower rates available. There are twice as many products on the market as two years ago, and competition has pushed rates down: the very lowest interest rates are now around the 2.5% mark.
But the costs can add up and critics warn that it is a high-risk move. Research from Key, an equity release advisory firm, found that between April 2020 and the end of June 2021, older homeowners withdrew £830m from their homes and gifted it to their offspring or others to use in a variety of ways. More than half – £425m – was handed to their children or other family members or friends to help them on to the property ladder.
Key’s chief executive, Will Hale, says the money has effectively been “recycled” – and that one of the driving forces was the stamp duty holiday, which started to be phased out at the end of June.
“In recent years, using equity release to facilitate intergenerational wealth transfer has become increasingly popular,” he says.
How does it work?
The most common equity release deals are mortgage-based products that are loans secured against your home. Typically there are no monthly repayments – the loan, including the interest that is accrued, is repaid from the sale of the property when you die or go into long-term care. These are known as “lifetime mortgages”. You can take the loan as a one-off lump sum or in smaller sums.
Lenders will base how much you can borrow on your age, the value of the property and sometimes your health. Interest rates on lifetime mortgages are typically higher than on standard mortgages. Comparison site Equity Release Supermarket shows rates from a number of providers run from 2.86% to 6.9%.
The minimum age at which you can sign up is usually 55, while the average age of a new customer currently stands between 68 and 70, according to trade body the Equity Release Council. Leading providers include Aviva, Legal & General, Just, more2life, LV= (Liverpool Victoria), Canada Life, Pure Retirement and OneFamily. Many of the firms have calculators on their websites that you can use to get an idea of how much you can borrow.
With a lifetime mortgage, the interest owed on the loan is added to the sum borrowed. You are then charged interest on this larger amount the following year, meaning the amount you owe can mount quickly.
The most flexible deals are those that include a feature called drawdown, where a pot of money is set aside for you to draw from as and when needed. Not everyone needs a big lump sum at the outset, and with a drawdown lifetime mortgage you only accrue interest on the money you have released.
The average lump sum released is £113,000, while for a drawdown customer it is an initial £85,000 with a further £34,000 held in reserve, according to Equity Release Council data.
The housing market’s turbo-charged performance during much of the pandemic has made the maths of equity release more favourable to some existing customers. According to government data, the annual rate of house price growth has been above 7% since January this year.
Based on that figure, the industry claims that house price rises over the last year may have balanced out the impact of compound interest for some equity release customers. “For example, a customer paying 6% interest may have seen their property equity grow faster than their debt, while a customer paying 3% interest could have seen their equity grow more than twice as fast,” says the Equity Release Council.
Just as with investments, though, past performance is no guarantee of future results – there is of course a risk that property prices will fall, and that would change the equity release maths completely. Members of the Equity Release Council have to have a “no negative equity guarantee” feature on their products. This means you or your estate will never owe more than the property is worth when the property is sold, even if property prices plunge.
While equity release has become much more common and mainstream, lifetime mortgages can be complex products with disadvantages. The former pensions minister and Conservative peer Ros Altmann says taking an equity release loan in your 50s or 60s is a high-risk proposition that should not be taken lightly. “The problem with taking out an equity release loan at such a relatively young age is that so much can change over the next 30 or 40 years, but once you have locked into an equity release loan, it can be difficult to get out of it,” she says.
“I believe equity release mortgages are still expensive and they do still pay generous commissions to the advisers who sell them or the brokers who find the clients for the equity release company. This is good for the lender, but may not be so good for the borrower. It can seem attractive to extract many tens of thousands or more from your home, but beware the long-term risks that these products can land you with.”
Borrowers who find that they can repay their loan early can face the prospect of “early repayment charges”. These may occur when either part or the entire amount is repaid before a date in the contract.
While equity release can sometimes have an image of being a way that asset-rich older people can tap into their property wealth to finance luxuries such as a new conservatory or round-the-world cruise, it can also enable people to provide life-changing financial assistance to family and friends. But for most people, the most financially effective way of freeing up cash is to move to a smaller property or cheaper area.
A 70-year-old with a £368,000 house is looking to release money from her property. Key looked at two scenarios for The Observer.
In the first one, the woman wanted to take out £78,000 as a lump sum. Based on an interest rate of 2.73% from more2life, the amount owing – loan plus interest – would be £102,452 after 10 years. After 20 years it would be £134,570.
Under the second scenario, with the same interest rates, she took out an initial £10,000 and then £5,000 a year. She would owe £71,403 after 10 years (£60,000 withdrawn in total), and £152,057 after 20 years (£110,000 withdrawn in total).
Many equity release products offer borrowers the opportunity to make interest repayments if they wish. If the same 70-year-old opted for the lump sum and paid 50% of the interest each month – £85 per month – that would reduce the total to pay after 10 years to £90,298, and the total outstanding after 20 years to £106,452.