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Equity release: your home as a source of cash

Other parts of this website have looked at your pension wealth, whether it’s in the form of your investments, or an income from an annuity or your state pension. But what if that’s not enough?

In that case, another obvious asset to tap is your home.

Equity release

The process of taking money out of your home in later life is broadly described by the catch-all term equity release.

The majority of equity release mortgages are available to borrowers aged over 55 or 60. Qualifying homeowners already supplement their retirement income by drawing equity from their properties in this way to the tune of several billion pounds per year. This is a trend that’s expected to grow fast.

But borrowing in later life is a big decision. You are draining value from an asset which you have spent a large part of your working life paying for. There are implications not only for your own future, but also for your children or other heirs. There are tax considerations, too, and most importantly, there is the cost of the debt to take into account.

Despite the sharp fall in interest rates, this type of borrowing is still expensive. Where possible, borrowing against your home in retirement as a means of topping up income is generally best avoided. If it is still something you are determined to consider, there are several types of mortgage that will help you to do this.

These different types of mortgage arrangement are covered below in answering the following commonly asked questions about equity release.

Before you decide to release equity from your home you should talk to family members, a trusted friend or solicitor – if only to benefit from another person’s view on the step you’re taking. Once these arrangements are entered into, they are very difficult to reverse.

I’m in my 60s – how much can I borrow?

This is one of the most commonly asked questions about equity release and the answer usually surprises people. There are very tight restrictions on the amount of your property’s value that you can borrow and they are linked to your age. The younger you are, the smaller the proportion of your property’s value that you will be able to borrow.

The lender – which is usually a bank, building society or insurance firm – will in almost all, if not all, cases provide a promise that the size of your loan will never exceed the value of your home. This is called the no negative equity guarantee. While such promises are the norm, it is still wise in every case to check the contract terms to ensure the promise is there in black and white.

This no negative equity guarantee means the lender is carrying quite a lot of risk. There is the risk that you will live for a very long time, which would push up the overall size of your loan (see below regarding the cost of the debt). There is also the risk that house prices might fall. As a result, lenders are cautious.

The following table comes from one major provider and highlights, by age, what proportion of your property you’re allowed to borrow. It also shows that lenders charge bigger, riskier borrowers more. The more you want to borrow, the higher the rate of interest you’ll have to pay.

How much of your home’s value can you borrow?

Where you are borrowing jointly with a spouse, the younger person’s age is used by the lender in determining the amount that can be borrowed.

How much will this borrowing cost me, in pounds and pence?

The most common types of equity release mortgages are known as lifetime mortgages. They charge a fixed rate for as long as the mortgage remains in force. That period is unknown: it is likely to be as long as you live, or as long as you live in your home before going into care.

You do not make monthly repayments as with a normal mortgage. Instead, the interest rolls up over the years. The interest is compounded – meaning interest is charged on the interest already owing – and so the total debt can mushroom, especially if you are paying a high rate.

The value of your house might go up in the meantime – or it might go down. Either way the proportion of your property’s value that you borrow at the outset is unlikely to remain the same throughout. You might borrow one-third of your home’s value, for example, at a high rate of interest (say 6%). After 30 years, assuming house price growth of less than 6%, your debts would be roughly two-thirds the value of your property.

The table below spells out a number of scenarios. It starts by assuming your home is worth £300,000 and that you borrow £100,000 at rates of 4.3%, 5% or 6%. You will see that the second column assumes annual house price growth of 4%. While no one knows what will happen to house prices in the future, this is a conservative figure for annual growth based on house price movements in recent decades.

How compounded debts can rack up fast

As you can see in the table, when you are not paying off the interest each month – as with a standard mortgage – the effect is to grow the total sum owed very quickly. That’s because you are being charged interest on interest. The higher the interest rate and the longer the loan, the more severe the effect, as you can see in the bottom right hand corner of the table.

There are ways to reduce the costs of the loan. Increasingly, equity release mortgages come with flexible features that can save money. One feature is a drawdown facility. With this, the lender effectively agrees a maximum sum that you can borrow. But you don’t have to take it all at once. You will only pay interest on what you borrow.

Say your home is worth £600,000. The lender agrees that you may borrow £250,000. Instead of taking it all at once, however, you take just £50,000 to begin with, as that is the sum immediately required. You are not paying interest on the entire agreed sum – as most remains to be drawn down if and when you need it in future.

Another feature is an ability to pay the interest as you go, rather than letting it accumulate and compound. This can be very useful in certain situations as it keeps down the overall cost of the debt.

But for this to work, you will need to have sufficient income to meet the monthly interest payments. When people are borrowing capital against their home to give to children, for example, it may be that the children could help meet the monthly interest bills out of their own wages. This then becomes a cost-effective way of transferring capital down a generation.

It could also help mitigate an inheritance tax liability where, for instance, those with large pension pots and valuable properties choose to live off capital raised via equity release and retain their pension intact. Because pensions are treated more generously for inheritance tax than property assets, savings can arise (we have more on inheritance tax here).

If I borrow this money, should I spend it or invest it?

Equity release lenders have conducted numerous studies into what people do with the money they borrow. Rather disturbingly, these reports suggest that many people leave the capital that they have drawn from their home sitting in a bank account. This is very poor use of your asset.

Not only are you paying a high rate of interest, compounded, for the privilege of having that capital to hand, but it is earning nothing itself with interest rates at record lows.

The simple rule is not to borrow unless you have a clear need for the cash. If you anticipate a future need for more money, make use of a flexible equity release arrangement where you can draw cash piecemeal, as it’s needed.

How does an equity release loan get repaid?

The money is repaid on your death, or sooner if you sell the property to go into care. Where a couple are mortgaged jointly the loan will run on until the second person’s death, or until they go into care.

In most cases you are not able to settle the loan for other reasons without paying a penalty. If, for instance, you inherited money, you would probably be unable to use it to pay off the mortgage.

The question of care costs

Elderly couples coming to grips with retirement finances are going to need to think about the costs of care. Under current rules, people whose assets (including savings, investments and their home) exceed £23,250 in value are generally expected to pay all their care home fees. The thresholds in Wales and Scotland are higher at £30,000 and £26,500 respectively.

The vast majority of homeowners who release equity will still retain ownership of enough of their property to have to pay for care. Indeed, local authorities have the power to pursue people who they believe might have disposed of assets deliberately in order to qualify for care assistance.

Either way, the issue of paying for care should be discussed by borrowers with their financial adviser (see more on advice here) and, ideally, other family members, before signing up to an equity release arrangement. 

‘Homes are now the main storage tank of wealth for large swathes of Middle Britain’

By Stephen Lowe, a director of Just, an insurer that specialises in retirement planning and financing, and an expert in care funding, equity release and specialised annuities.

For a nation supposedly obsessed with property we have been reluctant to factor in the wealth tied up in our own homes when making financial plans for the future.

This is now changing, driven in part by rising property values but also by a backdrop of lower returns and rising later life costs. The over-55s have an estimated £1.8 trillion tied up in their homes in England alone, a figure forecast to double in the next two decades.

Homes are now the main storage tank of wealth for large swathes of Middle Britain, perhaps not surprisingly given that many of us have poured more into mortgages than into our pensions. Of course, homes are more than just financial assets. We live in our homes and have an emotional attachment to them through our families and the local community.

The most common type of equity release plan is the lifetime mortgage, and competition in the market has driven interest rates down and encouraged innovation. The majority of lifetime mortgages are at a fixed interest rate, with about two-thirds of users drawing down funds over time and the rest taking lump sums.

Strict consumer safeguards now apply to the equity release market, in terms of regulation and codes of practice. The Equity Release Council is a good source of advice and its members must adhere to a comprehensive set of rules, ensuring customers receive regulated advice from a qualified professional and use an independent solicitor.

Equity release is not well understood. Research by the Tax Incentivised Savings Association found that while two-thirds of people claimed to understand equity release, on average they could only answer three out of 13 true or false questions about it correctly. For example, nearly one-third incorrectly believed taking an equity release loan meant giving up legal ownership of the house.

While not suitable for everyone, it is worth exploring as a way to a more comfortable life. Equity release is certainly a solution worth investigating for anyone struggling for regular income or to pay off an interest-only mortgage, or who wants to release a lump sum to use or give away while they are still alive.

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