What are the Pitfalls of Equity Release to avoid?

Equity release schemes are becoming increasingly popular. They offer older homeowners the opportunity to tap into some of the money tied up in their property without selling it. But there are pitfalls to sidestep. Here’s what you need to know.

Taking out more money than necessary

With a lifetime mortgage, it is best only to release the amount of money you need to achieve your goals. If you feel you may need additional funds, then a drawdown plan with a facility for further releases would be an option. 

A drawdown lifetime mortgage includes a pre-approved amount of money you will be able to release when you need to. You only pay interest on your released amount, not the approved amount. 

For example, you’ll pay interest on this excess money if you release more than you need. If you do not pay interest, it will roll up over time, and this will be compounded and can increase by a significant amount by the end of the loan. 

Releasing the maximum loan you are able is also likely to result in obtaining a plan at a higher interest rate. However, this is not always the case and depends on what schemes are available at the time of application.  

You could potentially lose state benefits you are entitled to

Equity release schemes are becoming increasingly popular among retirees looking to boost their retirement incomes. But there are some downsides to consider.

The government offers many benefits to help people during old age, including pensions, housing benefits and free bus passes. You could lose access to means-tested benefits if you take out an equity release plan.

Equity release advisors will use specialist software to assess how/if you will be affected as part of the process. 

You may be subject to early exit fees.

Equity release schemes are becoming increasingly popular, with older homeowners looking to cash out some of their savings without selling up. However, there are several things to think about before signing one up. Here are five things to know about equity release contracts.

1. What does it mean?

An equity release scheme allows you to borrow against the value of your property to pay off loans taken out to improve your home. This could include paying off existing mortgages, consolidating debts into one loan, buying furniture, replacing windows, or adding extensions to the house.

2. How much do I owe?

The amount you owe depends on how long you plan to keep the property. If you’re planning to live in the property for less than ten years, you’ll probably end up owing around £30,000. But if you plan to move abroad within the next few years, you’ll likely have to repay more.

3. Is it worth it?

There are pros and cons to equity release. On the plus side, you won’t have to worry about repaying the debt once you’ve sold the property – although you’ll still have to pay interest. And if you decide to sell the property later down the line, you’ll receive the money you owe.

Your debt can be increased by compound interest.

When interest is added to both principle (the amount released) and existing interest on the loan, the sum becomes more significant than either alone. This concept applies to compound interest, where the interest earned on money invested over time is compounded. 

For example, I invest $1,000 into my savings account, earning 5% annual interest. After 12 months, my investment has grown to $1,056.40. If I add another 3% interest to the balance, my investment now stands at $1,066.80 – a total increase of $16.60.

However, it is possible to serve the interest on many plans should you wish. 

You can’t leave your home as an inheritance.

If you become ill and pass away, your home will be instructed to be sold to repay the lifetime mortgage loan owed to the lender.

Some plans allow you to ring-fence a percentage of the property to pass on. 

A no negative equity guarantee ensures the estate does not have to cover any shortfall should the property significantly decrease in value. 

You may not be able to take out another loan against your house.

Although this can be the case, arranging a lifetime mortgage with a drawdown facility may be possible to obtain a ‘further advance’ with a lifetime mortgage. 

Equity release through a home reversion plan allows homeowners to borrow up to 90% of the value of their property without having to sell it. You can use cash to pay off debts such as mortgages, credit cards, or buy something else. However, once you’ve taken out a home reversion plan, you cannot apply for another loan against your home. If you do try, lenders could refuse because you’re no longer considered to be living there.

A lifetime mortgage is a type of equity release, the most popular type of plan. 99% of equity release consists of lifetime mortgages. These have added benefits as they can be ported to other properties or cleared entirely (subject to an early repayment charge). 

The two types of equity release are:

• Lifetime mortgages – These are loans. The interest can be paid or left to roll up until the plan holder dies or enters lifetime care, at which point the property is sold and the loan paid back. 
  
• Home reversion plans – where you repay the whole amount within ten years; and

Using a tied broker

A tiered commission structure is one-way brokers make money. But it might not always be the best approach.

Tiered commissions are where brokers charge different rates depending on how much you invest. For example, a broker could offer a fixed fee of £1,500 for a £10,000 investment. Or they could charge £2,500 for a £20,000 investment. A tiered structure allows the broker to earn a greater fee on larger loans. More common is charging a percentage of 1.5%-2% with a minimum advice fee of £1500-£2000. 

But there’s a problem with tiered commissions – they don’t necessarily benefit consumers. Some experts argue that tiered charges harm consumers because they force people into paying too much for financial products.

In contrast, independent advisers can provide impartial advice without charging fees based on the size of your portfolio. Instead, look for a low fixed advice fee from a ‘whole of market’ advisor who can compare different plans from a panel of lenders.

Using such an advisor could save you £1,000s throughout the loan. 

Equity release requires a customer to seek financial advice from a qualified and regulated person in this field.