How Does Equity Release Work – All You Need to Know

Unlocking the value of your property via equity release allows homeowners to benefit from any growth in their home. And they don’t need to sell their asset.

In the current climate, this could be particularly useful if they’re facing cash flow issues. So how does equity release work? This blog aims to shed light on the differences between equity release and mortgages. We’ll also look into the types, the reasons for considering releasing equity, and the benefits and risks involved.

As with any financial decision, it is important to seek advice to ensure your decisions meet your long-term goals. As we are a bridging lender and BTL mortgage provider, we are not a financial advisor. We recommend reaching out to a qualified advisor to discuss your options.

What is home equity and how does equity release work?

Before we look deeper into how equity release works, we need to cover the basics. Home equity is the value of a person’s financial interest in a property they own. Simply put, it’s the difference between your property’s value, and the amount of money you owe for a loan that’s secured against said property.

This means that home equity can fluctuate as you pay off your mortgage. It will also be affected as the value of your home increases or decreases with market conditions.

Releasing equity on your home allows you to release cash from the value of your property. Alternatively, you can gain a regular income. Usually, equity release allows homeowners of retirement age to access the value of their property without needing to sell it.

Difference between releasing equity on your home & getting a mortgage

Releasing equity from your home differs from getting a mortgage. Primarily, you already own a home and want to release value where you may not already have a mortgage in place. On the other hand, you would use a mortgage to buy a property or continue to finance it through to retirement.

Additionally, mortgages often require you to make regular repayments to pay off the borrowed amount throughout a loan period. This isn’t always the case with equity release arrangements.

Each financial option has different eligibility criteria as well. Equity release is usually aimed at homeowners aged 55 or over. Whereas mortgage eligibility mostly depends on the applicant’s income, creditworthiness, and deposit size.

By taking out a mortgage, the lender legally holds the property until you repay the loan. Equity release allows you to maintain ownership.

How do the different types of equity release work?

There are two types of equity release on your home: lifetime mortgage and home reversion.

Lifetime mortgage

The most common type of equity release is a lifetime mortgage. Here, you take out a mortgage that’s secured against your primary residence, while maintaining ownership.

With a lifetime mortgage, you can make repayments throughout the loan term. You can also let the interest roll-up. This allows you to make a lump sum payment at the conclusion of the loan period. That said, some providers do let you pay off the capital and the interest as well.

The amount you can borrow depends on various factors, including how old you are and the value of your property. Typically, the minimum age of a lifetime mortgage is 55. The percentage you can borrow tends to rise the older you get.

Some providers may offer higher loan sums to you if you have – or have had – certain medical conditions. If you want to reduce the size of your lifetime mortgage, you could explore a ‘no negative equity guarantee’. You could then make some repayments throughout the loan. Even if you don’t need to according to the loan agreement.

The ‘guarantee’ means any fees for agents or solicitors have been paid. So you or your estate don’t need to pay it at the end of the loan term. By making repayments, you will reduce the amount of interest that you owe at the end of the term.

By not paying off some interest, your loan could increase significantly. It could potentially infringe on the remaining equity of your home. However, you might be able to ring-fence a portion of the property’s value. This is particularly useful if you want to pass this value onto family members in the form of inheritance.

The lifetime mortgage amount and any interest accrued is usually paid back by selling the property. This could happen when the last borrower passes away, or if they leave the property to go into long-term care.

Please remember, we are not financial advisors. You will want to seek out expert guidance on your options before progressing with any long-term plans.

Home reversion

So, how does home revision equity release work? Here, you sell all or part of your home to a home reversion provider. They would either pay out a lump sum or regular payments. This effectively means you co-own the property with the provider (unless you sell the entire asset).

But, you retain the right to live there until you die – it’s your responsibility to maintain and insure the property. Typically, these payments amount to between 20% and 60% of the property’s market value (or the value of the part that you choose to sell). Generally, this grows in size the older you are.

For home reversion equity release, some providers have a minimum age of 60 or 65 before you apply. Although it is possible to ring-fence a portion of the property’s value, you must sell that specific part of the property to pass it on as inheritance.

It’s important to note that the retained portion of the property’s value will remain unchanged. Regardless of any substantial increase in the property’s overall value. Indeed, you could effectively ‘lose’ money by releasing equity, as you’ll lose any additional value that your portion of the property might have otherwise accrued.

When you pass away or transition into long-term care, the proceeds from the property’s sale will be shared among the remaining property owners. Again, if you feel like this option could be for you, you’ll want to work with wealth or financial planners.

Why would you release equity on your home?

There are many reasons why you might want to release equity on your home. For instance, it could provide an additional source of income once you’ve retired. It could even finance a home improvement project or renovation.

Alternatively, you could use equity release to pay off other debts. It would allow you to consolidate what you owe into one equity release loan. In turn, this could reduce monthly outgoings, and streamline your financial situation.

Finally, extra funds from releasing equity could cover any expense from healthcare or long-term care expenses. These bills may be especially prevalent among the elderly equity release target market.

What are the benefits and risks of equity release?

Benefits

If you take out an equity release arrangement that doesn’t require monthly repayments, you may be able to reduce your outgoings each month. If your property’s value has increased since you bought it, you can also unlock the growth without having to sell your property.

There are also products in the market that allow you to make payments that can reduce the size of the loan to a significant extent. Even if the lender doesn’t require you to do so.

Risks

However, it is important to recognise the risks of equity release as well.

For one, lifetime mortgages tend to have higher interest rates than their mainstream counterparts. This could cause the loan to grow substantially, leaving less for your family or partner when you die.

Elsewhere, it can impact any benefit arrangements from the state – particularly for long-term care – that might have otherwise been available.

Finally, the full market value of your home isn’t paid by home reversion. This could impact the value of your estate when you die as a portion of your property no longer belongs to you.

It could make it harder to sell or make changes to the home. You may also miss out on some the property’s value appreciation if it increases in value dramatically.

Do I need a broker?

While you don’t necessarily need a broker, they can be incredibly useful. They can ensure that you don’t miss out on all the financial options available to you before releasing equity on your home. They’ll be able to provide tailored advice for your financial goals, situation, and worries.

Indeed, with a wealth of experience, brokers can connect you with the lenders or providers who best match your needs. Terms and interest rates often vary greatly between providers. So brokers can ensure that you find the option that best suits you. This might include preferential rates or access to exclusive deals from a provider that only certain brokers can provide.

Finally, brokers who are regulated by financial authorities provide an extra level of protection. Therefore, they must deliver accurate information when working on your behalf.

As always, when it comes to making major decisions about your property investments, it is best to assess all the financial options that are at your fingertips. To find out more about what Market Financial Solutions does, head over to our website.