An Equity Release Plan Offers Retirement Income
The Pros and Cons of a Lifetime Mortgage or Home Reversion Plan
Nov 5, 2009
People are living longer than ever before, but longevity brings problems. A long retirement isn't so great for those who find that they just can’t afford to do the things they had dreamed of all their working lives.
But what if a cash-strapped retired couple have paid off the mortgage on a house worth £200,000? Equity release schemes are available to increase their retirement income by freeing some of the cash tied up in their home. They can choose between a lifetime mortgage and a home reversion plan.
The Equity Release Plan: For and Against
In principle, an equity release plan is straightforward. Perhaps the American term, reverse mortgage, best describes it: with an ordinary mortgage the borrower gets a house in return for money; with a reverse mortgage (or an equity release loan), the borrower gets money in return for a house.
Financial planning for retirement is essential, but equity release is not for everybody. Those concerned for their children’s future, for example, won’t be leaving nearly so much if a big debt has to be paid off on the house. Then there’s the fact that the sum realized will always fall far short of the full value of the property. Add to this the potential impact on means-tested benefits – when means increase, entitlement decreases – and the drawbacks are clear.
On the other hand, a childless couple who are ineligible for means-tested benefits might find an equity release plan an ideal means of augmenting their retirement income.
Regulation of Equity Release Schemes
Not so long ago, lack of regulation made equity release schemes a minefield even for the best informed. All that has changed with the involvement in the past few years of the Financial Services Authority (FSA). Equity release companies really do now have to mind their Ps and Qs.
As it happens, the providers had themselves long since recognized the need for equity release plan regulation, creating in 1991 their own voluntary body SHIP (Safe Home Income Plan). Crucially, SHIP members provide a no-negative equity guarantee, ensuring that no one is left owing money when the scheme comes to an end. Financial planning for retirement is less fraught than it once was.
The Lifetime Mortgage and the Home Reversion Plan
Equity release schemes take two forms: lifetime mortgage and home reversion. The most obvious difference between the two is that the first leaves the borrower as home owner, whereas the second makes the borrower a tenant. The minimum age in both cases is around 60, with older applicants getting a better deal.
- Lifetime Mortgage. With a lifetime mortgage, the borrower takes out an equity release loan secured on a property, the maximum available being around 45% of its value. The money may be taken as a lump sum, or in monthly installments. Instead of regular repayments, interest is rolled up to be paid when the scheme ends.
- Home Reversion. All or part of the home is pledged to a reversion company. No interest is payable, but when the plan ends, the company takes its percentage of the value of the sale. There is usually a choice between a lump sum and an investment.
Equity Release Loan Calculators
As an example of a lifetime mortgage, take a loan of £45,000 at 6.5% interest. Paid as a lump sum, this will have accrued £70,733 in interest after 15 years, leaving a total debt of £115,733. Taken instead in monthly payments of £250, the interest would be £30,087, and the debt £75,087. (In the first case, interest is paid on the whole £45,000 from the beginning; in the second, interest in the first year is payable only on £3,000, and so on.)
With a home reversion plan, it all comes down to percentages. Depending on age, the borrower might get anything from 30% to 70% of the value of the house (or that part of it which is sold). No interest is payable, though the reversion company will, of course, count on an increase in the value of the property.
There are plenty of equity release calculators available online, not all of which demand personal details.
Advice on an Equity Release Plan
For those who decide to include an equity release loan in their financial planning for retirement, expert independent advice is strongly recommended. Plenty is available, and good advice will more than pay for itself.
Source:
The FSA Moneymadeclear guide to equity release
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