What is the Difference Between Equity Release and a Lifetime Mortgage?
Equity release and lifetime mortgages are both types of financial products that allow homeowners to unlock the value of their property without needing to sell it. However, they are not exactly the same thing. The simplest way to explain the difference is that a lifetime mortgage is only one type of equity release, and the latter term also includes home reversion plans. There are important things to understand about all of these products, as we will explain below, including how they are structured, how they are paid back, and what types of homeowners they are suitable for.
If you need to release cash from your property for any reason, it is important to consider the available options, which will vary depending on your circumstances. For example, if you do not own your home outright and still have an existing mortgage to pay, some strategies will not be available. On the other hand, in some cases, you can release equity (for example, by remortgaging your property) in the form of a cash lump sum, and use this to pay the remaining equity on the mortgage.
In fact, releasing equity from your home is most commonly done by remortgaging it. However, there are several types of equity release that may be worthwhile. Some types are primarily suitable for older people, and do not ask for any monthly payments. Here, the property conveyancing experts at Clough & Willis Solicitors will explain how equity release works, discuss who it is most suitable for, and answer the question: “What is the difference between equity release and a lifetime mortgage?”
What is equity release?
Equity release means borrowing money against the value of your home, and if you are a homeowner over the age of 55, there can be many good reasons why you might consider this. It can help you to afford to make renovations to your property, provide you with any funds you need in an emergency, or simply enable you to be more financially comfortable during your retirement.
There are two main types of equity release, which can make things confusing. Even if you understand the fundamental differences, you may not be certain whether either option is right for you, based on your financial situation. These are the lifetime mortgage and the home reversion plan.
With a lifetime mortgage, you take out a loan secured against your home while retaining ownership of the property. Typically, you do not have to make any repayments during your lifetime, as the loan and any interest will be repaid when you die or if you need to move into long-term care. With that said, the interest rate on a lifetime mortgage is often high and will be compound interest, which means that it can stack up if you live in the home for longer than expected.
A less common type of equity release plan is a home reversion plan. This is essentially the opposite of a lifetime mortgage, and represents the partial sale of your home to a home reversion provider in exchange for a lump sum. As with a lifetime mortgage, you can continue to live in the property without paying rent until you die, but you will no longer own it.
What is a lifetime mortgage?
A lifetime mortgage is a financial product aimed at those over 55, which enables them to borrow money against the value of a house that they own, while retaining ownership over the property until they die, or until they move into permanent care. Once the property owner has died or moved permanently into care, the house is sold in order to clear the debt and any interest, although, in some cases, homeowners are able to make earlier payments. It is often advisable to make early repayments because of the ways in which interest accumulates, but we will explain this in more detail below.
You do not need to own your home outright in order to benefit from equity release. Instead, the amount of equity you can release is equivalent to the value of your property (as assessed by an independent surveyor when you apply for equity release) minus the value of any outstanding mortgage. In most cases, it is likely that your home will have increased in value over time, which can mean that the amount of equity you can release from your home under a lifetime mortgage is more than your initial mortgage was worth.
One of the most important things to be aware of is that the more money you borrow against the value of the house, the less will be left over once the property is sold. If you have a family and want to give them an inheritance when you pass away, you should remember that a property often represents the largest share of an estate, and if a large portion of the property's value goes towards paying off your debt, the estate that is inherited by your loved ones might be significantly smaller - even in cases where the money you borrowed has not been spent and is still part of the estate.
How does interest work with a lifetime mortgage?
In most cases, interest rates for lifetime mortgages are fixed, which makes it easy and convenient to plan ahead. However, it is important to assess each lifetime mortgage product on its own terms, and to understand how interest could compound over time to make this an expensive way of releasing money from your home.
You can either release equity as a lump sum, in which case, you will accumulate interest on the entire sum at once, or simply take the money as and when you need it. Under the latter circumstances, you will only owe interest on the money you have drawn out and will not need to pay interest on the total lump sum until you withdraw from it.
If you don't make repayments on a lifetime mortgage, interest can stack up quite quickly and in some cases could end up greater than the value of the house, which can cause significant financial problems for any next of kin you leave behind. In all cases, taking out a lifetime mortgage will reduce the value of your estate, which means you'll have less money to leave to your loved ones when you pass away. However, in most cases, there will be a limit on how much of the mortgage you pay back each year, so this is important to take into consideration when planning your finances.
What is a home reversion plan?
A home reversion plan is a different form of equity release. It enables you to sell all or part of your home to a third party, although, as with a lifetime mortgage, you can continue to occupy the house until you pass away. The third party may offer you a lump sum, or a regular income, in exchange for a portion of the equity of your house.
Once the house is sold, this company will take a share of the profits according to how much of the home you sold to them in the first place. For example, if you sell 50% of your home in exchange for £75,000 in cash, the home reversion company would be entitled to 50% of the proceeds from the sale of your property after you pass away.
The advantage of this is that the money you receive represents the sale proceeds from your home. Because it is a payment rather than an equity release loan, there is nothing to pay back when you die and no interest will accrue. However, you will receive less than the market value for the portion of the property you sell. How much you receive depends on how much equity you decide to sell, unlike an equity release mortgage which typically takes the value of your home in its entirety into account.
Who should consider a lifetime mortgage?
In most cases, these products become available when you are 55 or older. However, as we have noted, the high interest rate on a lifetime mortgage can cause the interest to build up over time. If you secure a lifetime mortgage at 55 and live for another 25 years, you can end up owing a significant sum. This will reduce the value of your estate, which can affect how much you can leave to your family as inheritance. However, selling part of your home to a reversion provider can also impact the overall value of your estate, and it is important to consider this when making any estate-planning decisions.
Due to the complexity and long-term impact of these products, it is vital to seek financial advice before making any decisions. There may also be an early repayment charge in some equity release schemes, or opportunities to have the interest rate fixed for a particular period, which could affect your decision making and your approach to strategy.
Our thorough knowledge of the legal ramifications of these decisions - particularly in terms of how they affect your estate and your loved ones' inheritance - can empower you to make the right decisions.
Speak to our property conveyancing experts for more information, you can call us on 0800 083 0815, or fill out our online enquiry form to arrange a call back.
