Blog > What are the pitfalls of equity release?

What are the pitfalls of equity release?

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By Clare Yates • 8th July 2023 • 10 min read

Drawbacks to consider and how you could manage them

Equity release is usually a lifetime commitment, so you should be aware of its pitfalls and potential solutions before going ahead with a plan.

We want all of our customers to be able to make an informed decision, so we’ve put this handy guide to help anyone wondering “what are the pitfalls of equity release?”.

In this guide to the pitfalls of equity release, we will explore the following:

  • How does equity release work?
  • The 10 pitfalls of equity release:
  • Pitfall 1: The cost of compound interest
  • Pitfall 2: An effect on entitlement to state benefits
  • Pitfall 3: Tax on savings interest
  • Pitfall 4: An impact on eligibility for homecare
  • Pitfall 5: Reducing inheritance for loved ones
  • Pitfall 6: Loved ones may incur inheritance
  • Pitfall 7: Early repayment charges
  • Pitfall 8: It’s an expensive option if you are younger
  • Pitfall 9: Releasing more than you need
  • Pitfall 10: Missing out on house price rises
  • Seeking equity release advice.

We hope this article helps you understand the pitfalls of equity release, but to speak to a specialist adviser about unlocking the tax-free money from your property, call our friendly team on 0808 178 3055, or request a call back. 

How does equity release work?

Equity release enables homeowners aged 55+ to unlock some of the tax-free cash tied up in the value of your home. 

There are two main types of equity release. The most popular option is a lifetime mortgage which is available as a lump sum or drawdown plan

The loan plus interest is typically paid back through the sale of your home when you pass away or move into permanent long-term care. This is why there are typically no mandatory monthly repayments.

Alternatively you can arrange a home reversion plan, which involves selling a portion of your property to a provider in exchange for a lump sum payment or a regular income. This is a less common form of equity release, but one or two providers still offer it.

Find out what’s possible for you: get a free quote or talk to one of our friendly consultants by calling 0808 178 3055 or request a call back.

The 10 pitfalls of equity release

As with any financial product there are benefits and drawbacks to consider. Some of them may be important to you and others may be less of a concern. It all depends on your individual situation and your financial goals for the future.  

To help you avoid an equity release horror story, here’s our guide to the ten main pitfalls of equity release. It’s an honest, ‘no-holds-barred’ summary of what to be aware of, with tips for potentially minimising the impact of each pitfall.

Pitfall 1: The cost of compound interest

One of the benefits of equity release is that there are typically no monthly repayments to make, as the interest can be left to roll up. However, the total interest on a lifetime mortgage can grow quite quickly due to the way in which it accrues. This can be a significant pitfall for some people.

This is because equity release providers charge compound interest. This means that after charging interest on the amount you borrow, they apply interest to the new loan total each month of year. In short, interest accrues on interest until the end of your lifetime mortgage. 

Manage the pitfall: If compound interest concerns you then consider an interest-only lifetime mortgage. This enables you to make regular payments to prevent or minimise interest rolling up on your plan. Another option is to choose a plan where you can make voluntary ad hoc payments of up to 10% of your overall loan each year to reduce the amount of interest that accrues. 

Read more about this pitfall of equity release in our article “How does equity release compound interest work?”

Pitfall 2: An effect on entitlement to state benefits

Some state and local authority benefits are means-tested, which means your eligibility for financial support is based on you proving that your income and/or capital falls below a certain amount. 

Naturally, if you receive a large amount of money as a lump sum, or your income increases, then you may no longer be eligible for those benefits. This includes Universal Credit and Pension Credit, for example.

How much savings and investments you can have before your eligibility is affected depends on which means-tested state benefits you receive or wish to apply for. 

Manage the pitfall: Make sure you get a full benefits check before exploring the option of equity release. You may even find that you are eligible for benefits you aren’t claiming yet. If so, you may not even need equity release once your income increases with the extra support. Our selected advisers can also help you assess the potential impact of equity release on your benefit entitlement.

Read more about this pitfall of equity release in our article: “How does equity release affect benefits?”

Pitfall 3: Tax on savings interest

You don’t pay any tax on the money you release with a lifetime mortgage or home reversion plan. However, if you release a lump sum and put the money into a savings account, any interest you earn on it could be subject to tax. 

This is one of the reasons why the general guidance is to avoid using equity release to boost your savings account. As well as potentially paying tax on interest, the amount of interest you will accrue on your plan is likely to far exceed any interest you make on your savings.

Our selected equity release advisers can provide more information on this. They may also recommend that you seek specialist tax advice to address issues around equity release and tax.

Manage the pitfall: To minimise the risk of paying tax on interest applied to equity release savings, you could arrange a drawdown lifetime mortgage. This lets you ringfence a cash reserve that you access in smaller amounts as and when you need it. 

Read more about this pitfall of equity release in our article: “Do you pay tax on equity release cash?”

Pitfall 4: An impact on eligibility for homecare

Some homeowners unlock a tax-free cash lump sum from their home to make adaptations to make their home more accessible. You might want to install a stair lift, a floor lift, or a downstairs wet room, for example. These changes can help you stay at home for longer.

However, there is a potential issue should you choose to use equity release to fund homecare. As we have discussed in the previous points, having a cash lump sum sitting in your savings can affect your entitlement to means-tested benefits. 

Should a financial assessment for homecare be carried out then they will check how much capital and investments you have. In England, you will not typically be entitled to help with the cost of social care from your local council if you have savings worth more than the upper capital limit. This is £23,250 currently, though it will rise to £100,000 from October 2025. 

Different rules and limits apply elsewhere in the UK. Please contact the Adult Social Services Department of your local authority for more information, or your Health and Social Care Trust if you live in Northern Ireland.

Manage the pitfall: By arranging a drawdown equity release plan you can access your money in smaller amounts over time. This could potentially keep your savings below the upper capital limit. 

Read our articles on care home costs and using equity release to pay for care for more information.

Pitfall 5: Reducing inheritance for loved ones

By its very nature, an equity release plan will reduce the value of your estate as you are unlocking some of the value of your home now, while you still live in it. 

In addition to the money you unlock, interest will accrue on your plan. As we explained in the first point, compound interest can grow quickly. This means that when you pass away, the amount of inheritance you leave will be less than it would have been. 

Manage the pitfall: Choose an interest-only equity release plan to prevent or reduce interest accruing. Some providers such as Aviva equity release plans also allow you to repay up to 10% of the loan itself each year, and this will also reduce the amount of interest that accrues. Also, some plans include the option of building in inheritance protection to ringfence a percentage of your home’s value so that your family will receive at least that amount in the future.

Read our guide to equity release and inheritance for more information.

Pitfall 6: Loved ones may incur inheritance tax

As we discussed in the previous point, one of the pitfalls of equity release is that it will reduce the value of your estate. This therefore means that a plan can reduce your inheritance tax (IHT) liability, as a plan may take your estate below the inheritance tax threshold.

However, if you release equity in order to make a gift to loved ones and you pass away within seven years, they may have to pay inheritance tax on what you gave them. 

When you pass away, the sale of your home will typically clear your equity release loan plus interest. After this is done, if your estate is valued at more than the IHT threshold then your beneficiaries will pay tax on any amount over it. This includes any money you gave away in the seven years prior to your death. 

Manage the pitfall: Inheritance tax can be complex, so please seek specialist tax advice if it is of concern to you. The issue of IHT will typically not be a concern if your estate is worth less than £325,000. In addition, if you are leaving your home to your children then your IHT threshold can increase to £500,000. 

Read more in our article: “Equity release and inheritance.”

Pitfall 7: Early repayment charges

As with any mortgage product there are likely to be early repayment charges (ERCs) to pay if you end your lifetime mortgage early. These penalties can be very expensive, especially if you have only had your plan for a few years. 

However, that isn’t to say you will always incur early repayment charges yourself as providers may offer exemptions. Examples of these include:

  • When repayment takes place after your death or the death of the second homeowner.
  • You or the second homeowner moves into long-term care.
  • The fixed early repayment charge term has expired.
  • You sell the property and transfer the mortgage to another suitable property.

Manage the pitfall: If you are considering equity release but think you might want to repay your plan early one day, make sure you communicate this to your adviser. They’ll be able to search for a plan that best suits your current and future financial goals, such as a plan with early repayment options or short fixed term ERCs.

Read more about this pitfall of equity release in our article: “Can you pay back equity release early?”

Pitfall 8: It’s an expensive option if you are younger

As compound interest accrues on a lifetime mortgage over the life of your plan, it can work out to be an expensive way to borrow money if you have the plan for many years. Equity release is available to homeowners aged 55 or over, so a younger customer could have their plan for over 30 years if they live well into their 80s.

To work out how much your plan could end up costing you, use our equity release compound interest calculator.

Manage the pitfall: There are many alternatives to equity release which might help you to achieve your financial goals now. You could then consider an equity release plan later in life when you have exhausted your alternatives.

If you are not yet 55 and in need of a cash boost, read our article: “How to release equity if you are under 55.”

Pitfall 9: Releasing more than you need

When it comes to unlocking tax-free cash from your home’s value, it can be tempting to go for the maximum release possible. But if you release more money than you need right now, you could end up with potentially tens of thousands of pounds sitting in your bank account. As you pay compound interest on the money you release, your loan can grow quickly in size.

Manage the pitfall: By choosing a drawdown lifetime mortgage, you can select the maximum release amount you want to have access to in your lifetime. You can then take an initial tax-free cash lump sum to begin with and unlock further amounts as and when you need the money. You will only pay interest on what you ‘draw down’ from your pot. 

Pitfall 10: Missing out on house price rises

If you arrange a home reversion plan then you sell all or some of your home to a home reversion company in exchange for a tax-free cash lump sum. You then live in your home for the rest of your life – or until you move into long-term care – as a tenant paying no rent.

This means that you will not benefit from any house price increases on the percentage of your home that you sell.

For example, if you sell 50% of your home to your lender and then move into a care home twenty years later, your home will be sold to repay your equity release plan. Your lender will keep 50% of the sale price and you will receive the other 50%. 

So in that scenario, if your home increases in value during the lifetime of your plan, you will only receive 50% of that additional equity, as you only own half of your home.

Manage the pitfall: By arranging a lifetime mortgage you will continue to own 100% of your property and will benefit from any increases to your home’s value. Once your home is sold and your overall loan is repaid, any monies left over will be paid to you or your estate. However, as mentioned previously, please remember that compound interest will build up unless you pay the interest each month, and this will reduce how much money is left after the loan is repaid. 

Seeking equity release advice

If you are thinking about arranging an equity release plan, make sure you speak to our friendly team. With many pros and cons to equity release to consider, you need a specialist who will take the time to address your concerns and find the best option for you.

Our selected advisers will honestly explain everything to you, arrange everything for you and guide you through the entire process, step-by-step.

Simply call us on 0808 178 3055 or request a call back and we’ll put you in touch with someone who can help. Alternatively, check your eligibility and get an initial indication of how much tax-free cash you could unlock.

About Clare Yates. With over a decade’s experience writing about later life financial planning, Clare offers a wealth of knowledge about equity release, pension annuities, wills, LPAs and more. When she isn’t writing, Clare likes to spend her time baking and going on walks with her husband, two children and their rescue dog. Follow Clare on LinkedIn

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