Money
Retirement
A guide to equity release - part two
If you are serious about equity release, it is essential to make sure you understand exactly what your options are, how they could work and what they could cost you, writes Jennifer Bailey
3. HOW TO DO IT - THE BASICS Before looking at the different products in detail, there are some basic criteria your circumstances must meet:
1) You (or the youngest if you are a couple) are at least 55 - in fact some schemes are only open to people over 65 or even 70.
2) You own your home outright - although some schemes will allow you to borrow enough to clear a small outstanding mortgage.
3) Your property is worth at least £60,000 (more for some providers) and is in a reasonable condition. Assuming you can tick ‘yes’ to all of those, you need to consider the two different kinds of equity release products available - the lifetime mortgage, and the home reversion plan.
THE LIFETIME MORTGAGE A lifetime mortgage works just like a traditional mortgage in that you borrow money using your house as security for the loan. This means the mortgage company has what is called a “charge” on your property. You can take the money as a cash lump sum or, more rarely, in the form of a regular income.
However, unlike a normal mortgage, there are no repayments made during the life of the loan. Instead the interest is “rolled-up”, that is added to the original amount borrowed. The longer you live, the more you owe. But usually the rate of interest is fixed for the length of the loan, which means you know in advance how the debt will grow over time.
At the point of sale, the mortgage company will deduct the original loan, plus the interest and any applicable charges from the proceeds. The no-negative equity guarantee offered by all SHIP providers means that the debt will never be more than the property is worth. Any surplus is yours or your heirs.
With this arrangement, there is nothing to pay until the house is sold - usually after your death or, in the case of a joint mortgage, after the death of the second person. The loan would also have to be repaid if you - or in the case of a joint mortgage the second person - went into long term care. Some schemes will however let you transfer the loan if you just want to move to another property.
HOW MUCH CAN I BORROW? The amount of money you can borrow will depend on your age (or whichever is the lower of your and your partner’s ages) and the value of your house. Most providers have a minimum amount they will lend - £30,000 is standard. Beyond that the amount is worked out as a proportion of the property’s value - with a typical loan worth between 18% and 50%.
The younger you are, less you will be able to borrow, because the likely value of the house when it is sold must be big enough to cover the original loan plus the interest which will roll up over the years. And of course the longer you live the more the debt will grow.
So the older you are the better.
WHAT WILL IT COST ME? In addition to the interest payments which will be added to the outstanding debt, there are also a number of charges to factor in. Some of these can be added to the loan, but at least a couple will have to be paid upfront.
In most cases you will have to pay a non-refundable valuation fee of about £300 when you apply for the loan. You should also budget around £500 for legal fees. And if, as is sensible, you go to a specialist independent financial adviser or broker you should expect to pay them a similar sum for arranging the deal.
Most providers will also levy an arrangement fee, typically around £600, which is payable at the start of the mortgage, but which is usually added to the loan. You are also likely to be charged around £30 to cover the cost of transferring the money, known as a “telegraphic transfer fee.”
David is 65. He lives with his wife Sue. Their house is worth £200,000 and they want to release £30,000. They take out a lifetime mortgage with an interest rate of 5.99%.
Their upfront costs total £1,445, being a valuation fee of £345, solicitors’ fees of £600 and brokers’ fees of £500.
In addition their lender charges them an arrangement fee of £599 and a telegraphic transfer fee of £35, both of which are added to the loan balance, which therefore starts at £30,634.
They make no further payments but each year interest is added to that total as below:
Year 1 Balance at start = £30,634.00 Interest - at 5.99% = £1,882.51 You owe at end of year = £32,516.51
Year 5 Balance at start = £38,904.87 Interest - at 5.99% = £2390.55 You owe at end of year = £41,295.42
Year 10 Balance at start = £52,444.48 Interest - at 5.99% = £3,235.73 You owe at end of year = £55,680.21
Year 15 Balance at start = £70,712.92 Interest - at 5.99% = £4,353.94 You owe at end of year = £75,066.86
(Source: Hinton and Wild)
So by the end of year 15, the £30,000 David and Sue borrowed will have grown to £75,066.68.
The effect of compound interest means the outstanding debt can grow very quickly, making this an expensive way to borrow, especially if you do not need the whole amount from the outset.
Many people take comfort from having a decent amount of money in the bank for a rainy day. But this does not really make financial sense, when you consider that it is extremely unlikely that you will be able to earn more in interest on your savings than is incurred by your debt - especially if you also have to pay tax on that interest.
