How does equity release work and what do you need to know?

If you own your home and are looking for some extra cash in retirement, equity release could be for you.

It is not without risks and will reduce the size of the estate you leave behind. 

But getting a loan secured on your property can provide you with tax-free funds to pay down debts, renovate your property or simply enjoy later life while staying in your existing home.

Extracting value: Equity release offers homeowners the opportunity to make use of the money tied up in their home, although they must pay interest and it will reduce their estate’s value

There are other options to consider, such as downsizing, a standard remortgage or taking out a retirement interest-only mortgage (Rio).

If you do decide to go down the equity release route, obtaining proper advice and choosing the right product and provider is key.

Interest on the loans ‘rolls up’ or accumulates over time, so a big part of this is making sure you aren’t on a higher rate than you need to be.

Lifetime mortgages, the most popular form of equity release, are more flexible than they once were, allowing people to draw cash only when they need it and in some cases pay interest if they choose to limit how debt rolls up.

Equity release rates have risen in the past year or so along with mainstream mortgages, so borrowers taking out the plans today are paying more interest than they would have pre-2022.

To help those considering equity release to make an informed decision, This is Money has partnered with leading adviser Age Partnership+.  

This is Money and Age Partnership+’s new equity release comparison tool allows you to browse the latest equity release mortgages and their respective rates.

It also allows you to sort the results by different product features, some of which could protect you from unexpected fees or payments spiralling out of control. 

This could include viewing only products which allow borrowers to make one-off or regular repayments to keep the interest down, or products offered by providers which meet the standards of industry body the Equity Release Council.

We explain how equity release works and what you need to know.

Staying put: A lifetime mortgage means that borrowers can stay in their existing home, as it is only sold to repay the loan after they die or enter long-term care

What is equity release?

Equity release loans, also known as lifetime mortgages and home reversion plans, allow homeowners to get a tax-free loan worth up to 60 per cent of their home’s value, while still remaining the sole owner.

They can use the money for anything they like, but popular uses include paying off debts, renovating their home, gifting money to friends and family or funding holidays or other hobbies in retirement.

Under a lifetime mortgage, the product that makes up the vast majority of equity release loans, the money only needs to be paid back via the sale of the house when the borrower dies or goes into long-term care.

However, some plans allow borrowers to pay back some of the money earlier if they choose.

All customers that have plans with providers that are members of the Equity Release Council are guaranteed the right to make penalty-free partial repayments of their loans.

Home reversion plans are a much less popular product where the borrower sells a percentage share of their home’s value to a lender for less than its market value. 

They get an agreed amount as a lump sum, but this is usually a lot less than the value of the share they have sold. They are then allowed to stay on as a tenant, but pay no rent, until they die or go into long-term care. 

The property is then sold and the lender gets its percentage share from the sale. As it is a percentage share, the amount the lender takes may have increased or decreased since the plan was taken out. 

Rolling up: Interest on equity release plans accumulates and is added to the loan if not paid off

If it increases over many years, the initial lump sum might start to look like expensive borrowing considering the profit that the lender is making. 

And if the value of the home decreases, the borrower’s estate could be left owing more money to the lender. 

Lifetime mortgages are a more popular and less risky option, so the rest of this guide focuses on those. 

It’s important to understand that equity release will reduce the value of your estate, and may affect your entitlement to means-tested benefits now or in the future. 

How is equity release interest calculated?

With a lifetime mortgage, interest will accumulate on the outstanding balance every month, and be added to the overall loan amount. 

Any unpaid interest is added to the loan, meaning the size of the loan will increase over time. The longer someone lives, the more interest will accrue. 

However, the total interest you pay will be less if you are paying some of the balance or interest off as you go, and more if you are making no payments.  

Interest rates on equity release products are higher than on mainstream mortgages, and currently range between about 6.5 and 9 per cent.

When browsing rates, the APR shows the annual cost of borrowing including additional costs, and the AER – annual equivalent rate – shows the overall cost of borrowing when the interest is compounded each year.

It is a good idea to opt for a plan where the interest rate is fixed for the life of the loan, as this gives you certainty about the amount you owe. 

If the rate on a loan is variable, make sure it has a cap and that you would be able to pay that increased amount.

There are also arrangement fees to consider when you first take out the loan.

How much can I borrow using equity release?

The maximum loan amount is usually between 55 and 60 per cent of the home’s value.

Like standard mortgages, equity release loans come with different loan-to-value bands, and the interest rates are generally lower for those that are borrowing less. 

For example, if your home was worth £200,000 and you wanted to release £80,000 of equity, you would be taking out a loan for 40 per cent of what the home is worth. In other words, your loan-to-value would be 40 per cent.

Eligible: Borrowers must own their home without a mortgage and use it as their main residence

As the loan only needs to be repaid after the borrower dies or enters long-term care, equity release lenders do not carry out the same kind of affordability checks that borrowers must go through when applying for a traditional mortgage.

However, from the borrowers’ own point of view, it is important to ensure they will still have enough money for retirement, and that they have a plan for how they will spend the equity release money so that they don’t burn through it too quickly. 

Equity release can affect borrowers’ eligibility for certain means-tested benefits, which could be important if, for example, they fall into ill health. However, it does not affect the state pension.

Borrowers also need to ensure they are comfortable with the reduced estate that they will leave behind for their loved ones, once the equity release lender has been paid back. 

Who qualifies for equity release?

Lifetime mortgages are are available to homeowners who are aged 55 or over.

They must own their home outright in order to use equity release, however.

If a borrower still has a mortgage on their home when they take out the equity release loan, they must use part of the loan to pay off their mortgage in full.

They must also use the home as their main residence, so equity release may not be suitable for ex-pats who spend the majority of their time abroad, or those planning to move in with family in their later years. 

Anyone taking out an equity release loan is legally required to seek professional financial advice first to check that it is suitable. 

Your equity release lender should provide this, but you could also opt to seek your own independent financial advice on top. 

Drawdown or lump sum?

Homeowners can opt for a drawdown lifetime mortgage or a lump sum lifetime mortgage.

Drawdown equity release mortgages allow you to take cash out of your home as and when you need, rather than in a single lump sum.

This means you would only pay interest on the money you had drawn down.

Lump sum equity release mortgages, meanwhile, allow you to access all of the cash from your home in one go.

Alternatively, you can opt for products which allow you to pay just the interest each month. There are also products that allow you to pay off both the interest and the loan amount each month.

What are the alternatives to equity release?

The decision to release cash from your home should never be taken lightly.

There may also be a better option. For example, selling up and downsizing to a smaller property may free up cash without any interest payments or charges attached.

You could also consider a retirement interest-only mortgage. This is a product which allows older homeowners to only pay the interest on their home loan until they die or go into long-term care.

After that, the outstanding borrowing is paid off by the sale of their home.

Alternative: Downsizing may be a better option for some over-55 homeowners

It is also possible for those in later life to stay in their own home and continue with their existing mortgage, or remortgage – as long as they have the financial means to do so.

If they needed to access some cash from their home, they could remortgage and increase the length of the remaining term, spreading the remaining payments over a longer period of time.

They could also remortgage at a higher loan-to-value in order to to release some equity from their property, though this will increase the time it takes to pay off the loan.

What if I need to move or want to pay back the loan?

All products approved by the Equity Release Council must allow borrowers to move home, as long as their lender accepts that the new property is a suitable continuing security for the loan.

This usually means that it is the type of property the lender would accept if it was setting up a new equity release plan.

In most circumstances, you will simply carry over the loan from your old property to the new one and the terms of the equity release plan will remain the same.

If you have a lifetime mortgage and you want to move to a property with a lower value, then the lender may require a partial repayment of the loan to keep it within its lending limits at the time.

Equity Release Council-approved lenders should not impose early repayment charges if you move your equity release plan to another home.

Usually, paying back an equity release loan in full before you pass away or go into long-term care would incur a penalty known as an early repayment charge, which would be set out in the terms of your loan and could run in to thousands of pounds.

However, some equity release mortgages have ‘downsizing protection’, which means that the customer can pay their equity release loan back in full if they move to a smaller home, without any charges.

What if my home sells for less than the loan amount?

This is something borrowers need to be aware of, although it is relatively unlikely. 

As the maximum borrowed via equity release is 60 per cent, it would need to lose at least 40 per cent of its value before you were in negative equity.

However, if this is something that concerns you it is worth knowing that products offered by ERC members must have a no negative equity guarantee.

This means that, if the money from the eventual sale of the home is not enough to repay the outstanding loan, the borrower or their estate will not need to pay any extra.

However, in such an instance those inheriting the estate would be left with nothing from the value of the former family home. 

You can compare equity release rates across ERC member products and find out more about how much you could potentially borrow with This is Money and Age Partnership+’s equity release comparison tool.