Cash-poor homeowners should beware of equity-release

Equity-release specialists report a surge in demand from homeowners in their sixties forced to stop work earlier than expected or concerned about the impact of Covid-19 on their finances. More people than ever before are turning to their homes to bolster their income. For the cash-strapped, equity release has never looked more appealing. Not only have house prices hit record highs, but interest rates are also historically low. The most competitive equity-release plans now carry annual rates of less than 2.5%.

But even at these lower rates, the cost of equity-release plans builds up over time, potentially leaving borrowers with little or no property wealth to pass on to children. The younger the borrower when they take out the equity-release plan, the higher the costs are likely to be.

Plan providers usually require homeowners to be at least 55 before they will lend to them.
In the past, however, the average borrower has typically been significantly older – often in their seventies – which makes the product more affordable.

This reflects the nature of the product. Most equity-release plans are mortgages secured against your home, but with no repayments due while you remain in the property. Instead, interest rolls up over time and is repayable, along with the capital borrowed, when you finally move out of the property, or on your death.

How the payments spiral

This structure appeals to homeowners who need to convert the capital in their homes into income. The mortgage can be drawn down over time or invested to generate an income – without having to worry about repayments. But with interest charges subject to additional interest, the total amount owed can spiral rapidly.

A 75-year-old homeowner releasing £60,000 of capital from a home worth £300,000 would owe around £77,000 by age 85, assuming an interest rate of 2.5% on the plan. Someone taking out the same plan at age 65 would owe almost £99,000 by the time they reached age 85.

However, today’s equity-release plans are more flexible. For example, drawing down cash as you need it, rather than in one lump sum, can keep costs down as you only pay interest on the money you have taken out of the scheme. You may also have the option of paying interest charges as you go along, cutting the total cost.

Still, financial advisers describe equity-release plans as a last resort for older people worried about their income. For many people, it may make more sense to downsize, freeing up cash by moving to a smaller property. It is crucial to take high-quality independent financial advice before opting for an equity-release plan.