Downsizing or equity release: which is best?
Downsizing – moving to a smaller home in later life – is far cheaper than an equity-release plan. David Prosser crunches the numbers.
Could downsizing be a good way for more older people to free up cash locked up in valuable property – and increase the stock of larger homes for families? Australia’s government has just announced changes to the law to give pensioners financial incentives to downsize. In the UK, however, many older people are reluctant to move home, even if doing so could make life more comfortable financially.
That partly reflects people’s emotional ties to their homes, but there is also anxiety about the cost of moving. Instead, older people tend to choose equity-release plans – sales have doubled over the past seven years – which allow them to stay in the property, borrowing against its value to generate cash that can be used to boost income or for another purpose.
At first sight, equity release looks cheaper than downsizing
Equity-release plans do not have to be repaid until after the death of the homeowner; the plan provider then gets a share of the proceeds when the property is sold. So, at first sight, the upfront costs of equity release appear to be much lower than the expense of moving house.
There are some fees to pay with equity release. You will need to cover the cost of having your property independently valued, and you will also require basic legal advice from a solicitor who understands this type of arrangement. You should also take independent financial advice, which will come at a price too. These costs are likely to total somewhere between £1,000 and £2,000.
Downsizing, however, will be significantly more expensive. You’ll need to pay valuation fees on the new house, and most people will want a proper survey of the property. You’ll need a full conveyancing service from a solicitor and there will be estate agent’s fees to pay on the sale of your home – 1%-2% of the sale price, say. You may also need to pay stamp duty on the purchase price of the new property.
Those costs add up. To sell an £800,000 house and then buy a £500,000 property, say, could easily cost you £30,000 in fees, taxes and commissions. Equity release, therefore, looks a far more economic option – and comes with none of the emotional or practical baggage of having to move home.
But in the long term, downsizing lets you keep more of your wealth
Crucially, however, a comparison of upfront fees overlooks the long-term cost of equity release. The average product in the market currently carries an interest rate of around 4.5% a year. With your interest rolling up over time, repaying the loan will be expensive. In the above comparison, releasing £300,000 through an equity-release mortgage priced at 4.5% would cost almost £270,000 in interest, assuming none of the money is repaid until the homeowner’s death 20 years later.
There are ways to reduce these charges. Equity-release plan providers do allow you to make repayments during your lifetime, reducing the debt and hence also the interest charges. There are also flexible options, such as the possibility of drawing cash down regularly, rather than as a lump sum, which reduce costs too.
Nevertheless, the high cost is one reason why equity-release plans tend to come a long way down the list of options that financial advisers suggest to older people looking to boost their income. Downsizing, if you’re prepared for the upheaval, is likely to preserve significantly more of your wealth.