Equity Release - part two
Equity Release - part three
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Equity release - part three
“Drawdown” offers what is potentially a much less costly way to borrow money through the lifetime mortgage route. The principle is the same, but the way you access the money is different and therefore much cheaper
ANOTHER WAY…
With this type of equity release product the mortgage company agrees to lend you an amount of money. But instead of taking it all at the outset, the idea is to draw down smaller amounts as and when they are needed. That can make a huge difference to the speed at which the debt grows.
Once again David and Sue arrange to borrow £30,000 but they do not need access to the money all at once. So in year 1 they take £3,000 to repair their roof. In year 2 they take £2,000 to visit their new grandchild in Australia. In year 3, they take £3,500 to buy a replacement car for Sue. In years 4 and 5, they draw nothing. This would mean at the end of year 5, they have only actually borrowed £8,500 out of the potential £30,000.
The charges remain the same, so they would still have to pay £1,445 in upfront fees and £634 would again be added to the initial £3,000. But because the amount of money they have actually used is smaller, the interest has grown much more slowly:
Year 1
Balance at start of year = £3,634.00
Amount borrowed in year = £0
Interest - charged at 5.99% per year = £217.68
What you owe at end of year = £3,851.68
Year 2
Balance at start of year = £3,851.68
Amount borrowed in year = £2,000
Interest - charged at 5.99% per year = £350.52
What you owe at end of year = £6,202.19
Year 3
Balance at start of year = £6,202.19
Amount borrowed in year = £3,500
Interest - charged at 5.99% per year = £581.16
What you owe at end of year = £10,283.35
Year 4
Balance at start of year = £10,283.35
Amount borrowed in year = £0
Interest - charged at 5.99% per year = £615.97
What you owe at end of year = £10,899.33
Year 5
Balance at start of year = £10,899.33
Amount borrowed in year = £0
Interest - charged at 5.99% per year = £652.87
What you owe at end of year = £11,552.20
Under this arrangement by the end of year 5, David and Sue have borrowed £8,500 and owe £11,552.20. Compare that to the earlier example where David and Sue released £30,000 at the start. In those circumstances by the end of year 5 they would owe £41,295.42.
“Drawdown” products are still relatively new but according to SHIP, the market is growing rapidly. Thirty percent more of these plans were sold in the third quarter of 2006 than in the same period in 2005. Advocates say they allow customers the best of both worlds - access to a large sum but in such a way as to limit the amount of interest incurred.
HOME REVERSION
A home reversion scheme is a completely different proposition to a lifetime mortgage.
With this product you sell a fixed percentage of your house to the reversion company. It pays you a cash sum or, very occasionally, a regular income, in return for the portion you have sold, and grants you the right to continue living in your home for the rest of your life, or until you decide to sell.
It is important to realise that with a reversion scheme you will no longer own all of your house. The proportion you sell belongs entirely to the provider. Occasionally it will charge a token rent (say £1 a month) but generally, as with a lifetime mortgage, there is nothing to pay until the house is sold. You remain responsible for maintaining the property as long as you live in it.
As with the lifetime mortgage the provider does not get its money back until the house is sold. But unlike the examples above when you would know at the outset what the debt would become, with a reversion the amount owed will depend on the value of the property at the time of the sale.
For instance, if you sell half your house to a reversion provider, it will be entitled to a 50% share of the proceeds of the sale, even if your house has greatly increased in value in the meantime. Say your house is worth £200,000 when you sell 50% of it. At that point, the debt is effectively £100,000.
But if, ten years later, when the house is sold, its value has increased to £400,000, then the reversion company would be entitled to half of that latest valuation, or £200,000. Of course the same would be true if the property fell in value - in the unlikely event that the company’s share was worth less than the amount it originally advanced it would have to absorb that loss.
HOW MUCH CAN I BORROW?
As before the provider will consider your age, your gender (because women tend to live longer than men) and the value of your property when deciding much it will lend you, and what proportion of your property you would have to sell to release that amount.
Because the company will have to wait to get its money back - and it cannot know how long you will live - it will pay you less than the market rate of the property at the outset.
So if, as in the example above, you sold 50% of a house worth £200,000 you would not receive £100,000. In fact, depending on your age, the amount you get would normally be between 35% and 60% of that £100,000. The older you are the more you would get because the company assumes it will not have to wait as long to reclaim its money.
WHAT WILL IT COST?
Just as with a lifetime mortgage, you should budget for a number of charges. As before you will have to pay a non-refundable upfront valuation fee of about £300 when you apply for the scheme. And again you should expect to pay around £500 for legal fees - although some solicitors charge more for advising on a reversion that on a lifetime mortgage because slightly more work is involved. Similarly brokers will sometimes charge their clients more for arranging a reversion than for a lifetime mortgage.
Reversion providers do not levy separate arrangement fees - their costs are taken into account when calculating the amount that can be released.
John is 70. His property is worth £200,000. He wants to release around £30,000. The reversion company will not buy less than 30% of his property or more than 90%. It offers him the following amounts:
Percentage Sold = 90%
Cash Released = £89,975
Percentage Sold = 70%
Cash Released = £69,980
Percentage Sold = 50%
Cash Released = £49,986
Percentage Sold = 30%
Cash Released = £29,992
In the end he decides to release 31% of his property value which gives him £30,991. His costs total £1,590, made up of a valuation fee of £240, legal fees of £650 and a brokers’ fee of £700.
John lives for another 15 years. By the time his house is sold after his death the value has increased to £350,000. The reversion company is entitled to 31% of the new valuation or £108,500. John’s family receives the remaining 69% which is worth £241,500.
4. WHAT ELSE DO I NEED TO THINK ABOUT?
Equity release products - of either kind - have some other potential financial consequences you may need to consider.
BENEFITS
If you currently get any income-related benefits such as pension credit or council tax benefit, receiving a lump sum or extra income from equity release could mean you are no longer entitled to as much or any of these benefits. Having a relatively large sum of money in the bank could also mean having to pay more for various associated things like dental treatment and glasses. In some circumstances it could also affect any charges you pay for care.
You are less likely to have problems if you release smaller amounts of money or spend the money you release straight away on things like home repairs. In addition, if you receive pension credit and have been told that an “assessed income period” has been set, not all changes to your circumstances will affect the benefits you receive. In that case you would not have to declare any new money until the end of the period, which usually lasts five years.
But you must make sure you understand if and how your benefits position could be affected before you take out either a lifetime mortgage or or a reversion. Contact the Pension Service or Citizens Advice.
TAX
Going down this route could also alter your tax position. Any money you release directly from your home is currently tax free. However if you choose to invest that money, any income it produces may be taxable, depending on your circumstances.
If your total income is higher than your tax-free personal allowance you will have to pay tax on the difference. If it is above £20,900 (in tax year 2007-08) you may also lose some or all of the “age allowance”, the higher personal tax allowance for people aged 65 and over. That could mean you pay more tax overall.
Equity release products can also affect the amount of inheritance tax due when you die. The money deducted from the proceeds of the sale of your house - whether to repay a mortgage company or reversion provider - will reduce the size of your estate and therefore the amount of inheritance tax due. But you should not take out a product for this reason - if you are concerned about inheritance tax planning you should take specialist advice.
Tax notwithstanding, given that equity release will reduce the amount of money you will leave to your beneficiaries, it may be a good idea to discuss your plans with them in advance.
OTHER POTENTIAL PITFALLS
Assuming you meet the other criteria, the biggest stumbling block is likely to be your property. Several providers will not accept flats, maisonettes or leasehold properties, especially those with less than 75 - 80 years remaining on the lease. Some will reject properties which are not built using materials such as cement or bricks. It can be difficult to find a provider if you live in an ex-council property. Many companies do not operate in Northern Ireland.
You may want to be able to move to a smaller property in the future if your circumstances change. Not all equity release providers will let you transfer your scheme, especially if you move into sheltered housing. Even if you can take the product with you, if you move to a cheaper property you will usually have to repay some of the debt from the proceeds of the first sale.
You may run into difficulties if you have signed an Enduring Power of Attorney which appoints a third party to deal with your financial affairs. Some companies will not deal with Attorneys, so if you are in this situation you may need to shop around before you find a firm who will deal with your representative.
And if you take out a scheme as a single person and subsequently get married, or decide to live with a partner you may not be able to transfer the scheme into your joint names. Any arrangement would therefore come to an end on your death and your partner may not be able to remain in the house. Similarly if a younger family member or friend moved into the house to help care for you, the house would probably have to be sold when you died.
6. FINDING THE BEST DEAL FOR YOU
If you are serious about equity release it is vital that you seek specialist independent financial advice. The products are complicated and the effects can be far reaching. You must ensure your interests are protected. To that end, all SHIP members will insist that you have an independent solicitor acting on your behalf as well.
Ideally you should contact a company which specialises in equity release and whose staff are fully qualified in this area. They will have a better understanding of the various products on offer, and will be able to advise on your personal tax and benefits position as well.
The SHIP trade body has produced a questionnaire designed to help advisors work through the key issues surrounding equity release, but it is also acts as a useful checklist for customers as well.
The Financial Services Authority has a number of detailed guides to equity release on its website.
Finally, remember that equity release is not right for everyone - the leading specialist advisers in this field turn away the majority of customers who approach them.
Make sure that if you are one of the minority who go ahead, you understand exactly what you are getting into, and what the real cost will be.
Written by Jennifer Bailey
This article was created: 15 January 2007.
This article was last edited: 31 May 2007.
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