Understanding the different types of equity release

There are two types of UK equity release

Two types of equity release are available to UK consumers: lifetime mortgages and home reversion plans. They share many similarities – but there are also crucial differences that consumers need to be aware of.

In this article, Clare Yates explains how both types of equity release plan work, including the main product standards and product features available to consumers:

• Introduction: what is equity release for?
• Lifetime mortgages.
• Equity Release Council product standards for lifetime mortgages.
• Lifetime mortgage product features.
• Eligibility for a lifetime mortgage.
• Home reversion plans.
• Equity Release Council product standards for home reversion.
• Home reversion product features.
• Eligibility for home reversion.
• Advantages and disadvantages of equity release.

About the author:

Clare Yates is a freelance writer specialising in later life finance. She has built up a wealth of knowledge about equity release, later life mortgages, pension annuities, wills and LPAs over more than a decade of writing in this sector. This has included editing the customer magazine for one of the UK’s biggest equity release broker firms, and writing for Retirement Line, the UK’s leading annuity broker.

Introduction: what is equity release for?

Equity release is one way that people aged 55 or over can turn some of the equity in their home into tax-free cash. There are other ways to do this, including downsizing to another property, but equity release is attractive to some people who prefer not to move home. 

Although it isn’t for everyone, for people who are ‘asset rich, cash poor’ (owning a home but receiving limited income or having insufficient savings), equity release may be a suitable way to meet financial goals. These can include such things as clearing an existing mortgage, funding home improvements, supplementing an income, paying for holidays or helping children or grandchildren onto the property ladder.

There are two main types of equity release plan:

• A lifetime mortgage, where the homeowner borrows money through a loan secured against their home and retains ownership.
• A home reversion plan where the homeowner sells all or a proportion of their home but continues to live there.

Lifetime mortgages

The most common form of equity release is a lifetime mortgage. This is a loan secured against the borrower’s home. The borrower retains full ownership of their property and has the right to continue living in it.

The chief difference between it and a conventional residential mortgage is that the borrower isn’t required to make regular repayments of the loan itself or the interest. Instead, the loan plus interest are typically repaid through the sale of the property when the borrower passes away or moves into permanent residential care. Alternatively, their family may be able to keep the property by paying off the loan and interest via other means.

Borrowers moving into long-term care will receive any money left from the sale of the property after the loan and accumulated interest is repaid. Should the borrower pass away, this money is paid to their estate for distribution according to their will, or the rules of intestacy if there is no will. 

Lenders will calculate the amount they are willing to lend based primarily on the applicant’s age and the value of the property. The older the applicant and the more valuable their property, the more money they are typically able to borrow. 

Interest rates

Lifetime mortgage lenders charge interest on the loan, linking their interest rates to what’s happening in the economy. Equity release interest rates are in particular linked to rises and falls in the price of government bonds and the return on them (known as gilt yields). 

Lenders also base the interest rate they offer to each applicant on other factors, including the loan to value (LTV), the property’s location and characteristics and so on. This guide to equity release interest rates explains further and includes information about the market’s best interest rates for lifetime mortgages. 

Compound interest

Interest on lifetime mortgages is charged on a compound or ‘roll up’ basis. The lender charges interest on the loan capital, and on the interest already accrued. This is in contrast with a standard residential mortgage where the lender typically charges interest only on the original loan amount.

Compound interest is more expensive than typical mortgage interest. However, it reflects the fact that the lender is taking on the uncertainty and risk of not knowing when the loan will be paid back. This guide to equity release compound interest explains further and includes a compound interest calculator tool.

Equity Release Council product standards for lifetime mortgages 

The Equity Release Council has developed five product standards and requires its members’ lifetime mortgage products to meet them all. Alternatively, the product literature must explain which standards are not met and explain the types of risk that this might pose for the borrower.

The product standards are as follows:

‘No negative equity’ guarantee. This protects the borrower or their estate from paying any money if the value of the property doesn’t cover the full amount of the loan and interest when repayment is needed.

The right to stay in your home. As long as borrowers abide by the provider’s terms and conditions, this guarantees that they can stay in their home until they pass away or move into long-term care. 

The right to move your loan to another property without penalty. Borrowers have the right to transfer their lifetime mortgage to a different property and move home with no fees for doing so – as long as the new property meets their product provider’s lending criteria as continuing security on the loan.

The right to make penalty-free partial repayments of the loan. Each provider has their own criteria which determine the upper limits for how much borrowers can pay each year before incurring early repayment charges. For example, Aviva and Just allow penalty-free repayments of up to 10% of loan each year.

Fixed or capped interest rates. Interest rates on each new release are either fixed for the life of the lifetime mortgage or, if variable, are capped at a stated maximum level.

Lifetime mortgage product features

In recent years, equity release providers have started introducing a number of optional features across many lifetime products. Not all products offer all of these however, so borrowers should look closely at the features available with any lifetime mortgage they are considering.

Drawdown facility. Drawdown lifetime mortgages let borrowers take an initial release followed by further cash as and when needed. This feature helps to reduce the overall cost of compound interest on a lifetime mortgage.

Optional interest payments. Interest-only lifetime mortgages give borrowers the opportunity to make voluntary full or partial interest payments on the loan each month. This prevents or reduces interest from accumulating.

Enhanced rates for ill health. Some lifetime mortgage providers offer higher cash releases or a preferential interest rate for certain medical conditions or lifestyle choices.

Inheritance protection. Some products allow the borrower to ring-fence some of their property’s value to ensure that there will be an inheritance to leave.

Downsizing protection. After a specified number of years, some providers allow borrowers to repay the loan and accumulated interest, sell their home and move with no early exit fee.

Early repayment fee waiver. Some providers waive an early repayment fee if, in the case of a joint lifetime mortgage, one of the borrowers dies and the other borrower wishes to repay the loan plus accumulated interest within a specified time.

Eligibility for a lifetime mortgage

Eligibility criteria differs across UK equity release providers, but typically borrowers need to be 55 or older and a UK resident. In the case of a couple applying for a lifetime mortgage, the youngest applicant on the deeds of the property must be the provider’s minimum age or older. There is no typical maximum age, and each equity release provider has its own criteria. 

There is also a minimum property value for each lifetime mortgage product. This is typically £70,000 on ‘standard’ properties such as houses of standard construction (although for some providers it can be more). However, it can differ for some property types, and for example is typically £100,000 on certain properties including ex-council properties. 

Some types  of property and some properties in certain locations may not be eligible for a lifetime mortgage. This is because lenders rely on properties being saleable, since a sale at the end of the plan is how the loan plus interest are typically repaid. They may be unwilling to accept properties that could make resale difficult, such as properties in non-residential areas and properties of non-standard construction.

For leasehold properties, lenders will typically require that the length of the remaining lease is of a certain length. Each lender will also have its own eligibility criteria for leasehold properties. They may for example simply require that the lease has a set number of years remaining. Others will use a calculation that adds the remaining lease length to the age of the borrower, or the youngest borrower for a joint application, and this total must be at least a specified minimum.

Home reversion plans

A home reversion plan is the second, much less common type of equity release. This has many similarities with a lifetime mortgage, including the fact that there are no compulsory regular repayments to make. However, it is a different product with crucial differences.

The main difference is that home reversion is not a loan in the normal sense. Instead, it involves the homeowner selling all or part of their property to a home reversion provider. Providers pay considerably less than the current market value of the property. Typically, the older the customers, the more they can receive, in a range somewhere in the order of 30–60% of the market value. Unlike a lifetime mortgage, no interest accrues on the money paid to the homeowner.

The customers then stay in their home as tenants, paying no rent, until the home is sold when they pass away or move into long-term care. When the house is sold, the home reversion provider receives the proceeds for their share of the property. The customer or their beneficiaries receive the proceeds from the sale of their share, should  a proportion be sold to the provider rather than the whole property.

Equity Release Council product standards for home reversion

Of the five Equity Release Council product standards listed above, four of them apply to home reversion plans as well as lifetime mortgages. The exception is the guarantee of fixed or capped interest rates. This does not apply to home reversion plans as there is no interest involved with this type of equity release.

Home reversion product features

Depending on the provider, home reversion plans may have some or all of these features for homeowners:

Instalment facility. Customers may be able to take payment in a number of instalments (typically annually) instead of a single lump sum. This may enable them to receive more money overall.

Enhanced pay out rates for ill health. Customers may be eligible for a greater cash release if they have certain medical conditions or lifestyle factors.

Inheritance protection. Home reversion plans in effect come with built-in inheritance protection if the homeowner chooses to sell a percentage of their home to the provider rather than all of it. This is because they can leave the remaining share to their beneficiaries. The amount they can leave will of course depend on the property’s future market value.

Eligibility for home reversion

As with lifetime mortgages, eligibility criteria differ from provider-to-provider. The minimum age for applicants is typically higher than with lifetime mortgages, typically 60 or above. This applies for the youngest applicant when a couple makes a joint application.

The minimum property value for home reversion may also be higher. For example, the leading home reversion provider Crown Equity Release has a minimum property value of £100,000. 

In terms of the property itself, providers will want to assess the future value and saleability of the property. However, home reversion providers may accept properties that lifetime mortgage providers have declined, such as certain leasehold properties and homes of non-standard construction.

Advantages and disadvantages of equity release

As with other financial products, there are some disadvantages of equity release as well as potential benefits. Consumers who are considering this form of later life financing should be aware of these before committing to a decision about equity release.

Equity Release Wise has prepared this guide to the pros and cons of equity release to help anyone considering equity release to make an informed choice. It is also recommended that consumers seek help from specialist advisers who can help establish whether equity release is suitable, and if so which type of plan and product features are best suited to their needs.

Advisers will take into consideration a wide range of factors, including the applicant’s age, property value, current financial situation and lifestyle requirements, and how their situation and needs may change in the future.