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The little-known equity release terms that could cost borrowers an extra £20,000

Equity release terms
Equity release terms

Demand for equity release is soaring: a record £1.6bn was unlocked from the value of borrowers’ homes in the second quarter of 2022. While a raft of regulatory changes have improved standards in the industry, there are still terms and conditions that can catch people out.

Many people who consider equity release will be aware that a major risk of borrowing money against their property is compound interest, which means the longer the borrower lives, the more the debt will grow.

As of March 2022, new plans have allowed the repayment of interest and up to 10pc of the initial capital borrowed to prevent this.

However, there are other, lesser-known features of equity release that could have a serious impact on how much the borrower ends up owing.

Downsizing? You may have to pay a fee

Later down the line, borrowers may decide they no longer want to live in the property from which they unlocked equity. All loans offered by lifetime mortgage providers that belong to the trade body the Equity Release Council are “portable”, which means they can be transferred to other properties.

However, you cannot necessarily transfer lifetime mortgages to all types of property.

Steve Wilkie of lifetime mortgage broker Responsible Life said: “The terms and conditions will frequently say that lenders must deem the property ‘suitable’. What this often means is that lenders will not allow the loan to be transferred to a home in a retirement village that has onerous maintenance or service charges. These charges can drastically affect the willingness of the lender to lend, even if you’re trying to take out a lifetime mortgage for the first time.”

Those who want to downsize to a property deemed unsuitable by the lender may have to repay some of their loan and – unless the plan has downsizing protection – could be hit by the early repayment charge.

According to Stuart Powell of broker Ocean Equity Release, most lenders will now waive the early repayment charge if the property is not one on which they will lend.

Unclear penalties

If you want to repay the loan early or repay more than the agreed amount (usually around 10pc a year, according to the Equity Release Council), you will probably incur a penalty.

There are two main types of penalty: fixed rate and gilt-linked.

As its name suggests, the size of a fixed-rate ERC is known from the outset. So if someone took out a £132,000 loan – which was the average amount people released in June, according to the Equity Release Council – and the ERC was fixed at 10pc, they could be confident that they would pay £13,200 should they ever be charged the ERC.

Many fixed ERCs will be even lower than this and they can also taper. For example, the penalty might be 10pc in year one, 5pc in year five and 3pc in year three.

Gilt-linked ERCs, by contrast, are tied to the price of government bonds, so the size of the penalty depends on how much gilts have risen or fallen since the borrower took out the loan. This means the ERC could be smaller than if the rate were fixed – but there is also a risk that it could be much larger.

Most variable penalties are capped at 25pc of the amount borrowed. Assuming that the same borrower had taken out a plan with a gilt-linked ERC and gilts had fallen so far that the ERC hit the 25pc cap, they would pay not £13,200 but £33,000 in fees.

Because of their complexity and because advisers cannot predict how big the penalty could be, many brokers, such as Mr Powell, believe gilt-linked penalties should be phased out.

He said: “Many brokers find gilt-linked penalties tricky – let alone clients. Under the Financial Conduct Authority’s new ‘consumer duty’ next year, I believe they will have to disappear completely. The overarching principle of the consumer duty is that ‘consumers should receive communications they can understand [and] products and services that meet their needs and offer fair value’.”

Gilt-linked penalties now make up just 13pc of the market, down from 54pc in 2020, according to equity release firm Key.

Analysis by Defacto, a financial data firm, shows that some lenders, such as Canada Life, OneFamily and Standard Life, offer only loans with fixed-rate penalties where with Aviva, Just, Legal & General and Pure Retirement, borrowers are given the choice of either a gilt-linked or fixed penalty.

The Equity Release Council said it was working with members to simplify the language used to explain fees and charges across the market to help customers understand and compare products.

Not all providers offer a ‘compassionate window’

Some plans will waive the penalty under certain conditions. In most cases there is a “compassionate window” of typically three years after an event such as the death of a spouse during which an early repayment charge would be waived.

But some policies do not come with a compassionate window. This could be especially challenging if the event in question has a significant impact on your finances.

There are other scenarios in which some providers would waive the fee and others would not.

If the borrower has to move into care and there is no surviving partner living in the property, it will be sold and the equity release provider paid back, with no early repayment charge.

But the borrower might decide they want to move in with a family member rather than go into care. Some policies will involve an early repayment charge in this instance. Certain lenders will waive the charge only if your medical needs specifically require you to move in with a relative.

Reader Service: Do you know if you can sell your house after releasing equity from it? Dispel the most common equity release myths, or discover how much you could unlock with the equity release calculator.