The pros and cons of equity release

Understanding the opportunities and potential pitfalls of equity release

Equity release has become a popular way for homeowners aged 55+ to unlock some of the tax-free money tied up in their bricks and mortar, without having to sell or move house. 

However, as with other financial options, there are some disadvantages of equity release, as well as potential benefits.

If you are considering this form of later life lending, you might be wondering what the advantages and disadvantages of equity release might be. To help you decide if it’s right for you, here are some of the main equity release pros and cons that you may wish to consider.

After familiarising yourself with the pros and cons of equity release, why not contact our friendly team to find out more? Talk to our friendly consultants by calling 0808 178 3055 or request a call back.

On this page:

• How does equity release work?
• Advantages of equity release
• Disadvantages of equity release
• Weighing up the pros and cons of equity release
• How can I minimise the pitfalls of equity release?
• Is equity release a good idea?

How does equity release work?

Before we get into the pros and cons of equity release, let’s take a minute to explain how it works. Equity release is a way to unlock some of the value in your home as tax-free cash to spend however you wish — whether that’s funding home improvements, helping out family, boosting your retirement income, or just about any other legal purpose.

The most common type of equity release is a lifetime mortgage, where you take out a loan and put your home up as security. You still own your home and there are no mandatory monthly repayments. Instead, both the loan and the interest that accumulates are repaid when you pass away or move into long-term care. At that point, your home is sold, and the proceeds are used to pay off the debt, with any remaining funds going to your estate.

A less common form of equity release that you might have heard of is a home reversion plan. This is where you sell all or a proportion of your home and continue to live there rent-free until you pass away or move into long-term care. We’ll talk about home reversion plan pros and cons a little later.

Most conversations about home equity release pros and cons are likely to begin with the issue of interest. As we’ll see, one of the disadvantages of a lifetime mortgage is that the interest typically ‘rolls up’, meaning it compounds over time. Every month, interest is added to the loan amount and to the interest due, which can quickly increase the overall debt. This can make it more expensive than a typical repayment mortgage. 

However, if you wish, you can opt for an interest-only lifetime mortgage, which allows you to pay off some or all of the interest each month. This helps prevent the loan from growing too quickly – or at all – and keeps more equity in your home for you or your heirs.

Additionally, some lenders allow voluntary partial repayments without financial penalty, giving you further control over how much interest builds up.

This form of later life finance isn’t for everyone, so it’s important to be aware of the pros and cons of equity release before making a decision. By understanding the different plans and schemes, you can decide whether to proceed and if so, which option best suits your financial needs and long-term goals.

Disadvantages of equity release

Equity release isn’t for everyone, and it’s important to understand the potential disadvantages of equity release and risks of this form of finance:

• One of the main negatives of equity release is that it will reduce the value of your estate and the amount of inheritance you can leave to your family. As the loan plus interest are repaid from the sale of your home, there will be less equity left to pass on to your beneficiaries. For those who wish to leave the maximum inheritance possible, this is an important consideration. However, some equity release plans offer ‘inheritance protection’, which allows you to ring-fence a portion of your home’s value to protect it for your loved ones.
• Another equity release negative to consider is that the total loan amount can grow quickly as the interest rolls up on a compound basis. Compound interest means that interest is applied each month to the original loan amount plus any interest already accrued. Over time, this can cause the debt to grow rapidly, which reduces the equity in your home. It’s important to understand how much the loan could increase over the years and consider options like making voluntary payments if the interest is a concern for you.
• Releasing money might affect your entitlement to some means-tested state benefits. If you’re receiving or planning to claim state benefits like Pension Credit, or other means-tested support, then receiving cash through equity release could affect your eligibility. It’s vital to check how releasing equity might impact your financial situation before proceeding.
• If you are receiving homecare which is fully or partially funded by your local council, then your eligibility may be affected, or you may have to pay more towards it. If you’re currently receiving care or expect to in the future, it’s essential to understand how accessing the equity in your home may affect your care funding.
• There may be early repayment fees to consider if you wish to repay the loan plus interest early, although some lenders waive these in some circumstances. While some equity release plans allow early repayment without penalty, others may charge hefty fees if you wish to repay the loan before certain conditions are met. It’s important to talk to your adviser if you think you might want to repay the loan early, so they can search for the best plan for your needs.
• If you give some of the money you release to family or friends as a gift, they may be liable to pay inheritance tax in the future. Although the money you receive from equity release is tax-free, if you gift it to others and pass away within seven years, those gifts could be subject to inheritance tax. This applies if your estate, including the value of any gifts, exceeds the current tax-free threshold, which is £325,000. It’s important to plan carefully, especially if you intend to use equity release to support loved ones.

Home reversion plan pros and cons

Home reversion plans are a less common type of equity release where you sell part or all of your home to a provider. While they can offer some advantages, they also come with drawbacks to consider. It’s important to weigh up all the home reversion plan pros and cons carefully before deciding if this option is right for you.

In addition to the main pros and cons of equity release that we have already talked about on this page, there are some extra points which relate specifically to this type of plan: 

Pros:

• You may be able to unlock a larger cash sum compared to a lifetime mortgage.
• No interest accumulates on the money you receive.
• You continue to live in your home with the same rights as a tenant, rent-free, for the rest of your life or until you move into long-term care.
• If you only sell a percentage of your house to the home reversion company, rather than all of it, you can leave your remaining share to your family. This guarantees them an inheritance.

Cons:

• You will sell part or all of your home at a price that is considerably below market value. You will almost certainly raise more money by selling the property in a more traditional way.
• You will no longer fully own your property. You may therefore be restricted in what you can do with the property, compared to if you retain full ownership. Make sure you properly read your chosen provider’s terms and conditions. 
• If your house increases in value in the future, you will only benefit from an increase in value of the proportion of your property that you still own (should you choose a partial sale of your property). 

You can read more about home reversion schemes.

Weighing up the pros and cons of equity release

You can see from the various pros and cons listed above that equity release can offer financial relief and flexibility, but it’s not without its risks and considerations. 

With that in mind, it’s essential you research your options and seek financial advice from a qualified specialist like our selected advisers.

They can check if any disadvantages of equity release could be a potential issue for you, and weigh these up against the benefits of equity release which are most relevant to you. This will help you decide if a plan will align with your long-term financial goals. 

How can I minimise the pitfalls of equity release?

We have listed six of the main potential equity release negatives above, but there are ways to minimise many of the pitfalls of equity release:

Reducing the overall cost of the loan

The impact of compound interest on the total cost of a lifetime mortgage may be one of the main disadvantages of equity release that concerns you. With compound interest, lenders add interest to the loan AND to the interest previously charged.

This means that the amount paid back when you pass away or move into long-term care might be considerably more than the original loan. This will eat into any inheritance you leave when you die, or into any money you receive from the sale of your home when going into long-term care. 

However, it is possible to reduce the impact of compound interest. By taking out an interest-only lifetime mortgage, you agree to make interest payments each month. If you pay the full interest and make every payment, all that’s repaid when the plan ends is the loan itself. Alternatively, all plans approved by the Equity Release Council allow you to make payments whenever you wish towards the interest to reduce the amount payable at the end of the plan.

Inheritance protection

Another way to address the pitfall of equity release where the value of your estate is reduced, is to choose inheritance protection when taking out a plan.

Many lenders give you this option, where you ring fence a proportion of your home’s value outside of the equity release plan. Regardless of how much interest accrues on your plan, however much equity you set aside will be there as a guaranteed inheritance when your plan ends. 

To demonstrate this, here is a simple example:

• You are eligible to release 50% of the value of your home, which has a value of £300,000.
• Instead of taking all of the available £150,000, you take £50,000.
• This leaves £100,000 as the inheritance guarantee.
• If your property increases in value, the actual amount protected will also increase, as lenders base this on a percentage of your home’s value.

Some of the non-protected value of your home may also be available as an inheritance. How much will depend on the size of the loan plus interest and the value of your property when you pass away.

Inheritance tax planning

As we mentioned under ‘Disadvantages of equity release’ above, another of the potential equity release negatives is that inheritance tax may be payable on money you gift to your family from your release.

However, your estate would only pay inheritance tax on this gift if you pass away within seven years. Also, it is typically only payable when your estate including the gift is valued above the current threshold (please check gov.uk/inheritancetax for the current threshold.)

We would suggest that you receive professional advice from a suitably qualified and authorised tax specialist if you wish to look at the inheritance tax implications of releasing equity to gift to loved ones.  

Minimising repayment charges

As with other types of loan, you may incur early repayment charges if you wish to repay the loan early. This may not be a concern to you if you have no intention of paying the loan back early. However, if it’s something you may consider in the future, it’s worth looking at different lender’s terms and conditions when choosing your plan.

For example, some lenders offer ‘Significant Life Event Exemptions’ where there are no early repayment charges in some circumstances. These may include your partner passing away or moving into long-term care. Lenders may also offer ‘Downsizing Protection’ where you can repay the loan without penalty when downsizing, once you have had your plan for a few years.   

Protecting your eligibility for benefits or care costs

Releasing equity could have a negative impact on your eligibility for certain means-tested benefits, or for at-home care funding. In some cases, the authorities take the amount of savings you have into consideration when assessing you for these benefits.

One way to potentially mitigate against this risk is to take your cash releases in stages with a drawdown lifetime mortgage rather than as a single lump sum. 

By carefully considering the pros and cons of equity release in relation to its effect on your benefits entitlement, you may be able to manage the risk of losing out. We would suggest that you talk to Citizens Advice or appropriate government agencies if you are in any doubt about how releasing equity might affect your entitlement to benefits.

Is equity release a good idea?

Many customers ask us the question ‘Is equity release a good idea?’. The answer is always the same: whether the potential disadvantages of equity release are outweighed by the advantages depends on your personal circumstances. 

For some older homeowners and their loved ones who might be struggling financially, equity release can be nothing short of a lifeline. For others, equity release is an opportunity to tap into their booming property wealth to enjoy a more luxurious retirement. 

Whatever your reasons are for wanting to unlock some of the money from your home, our selected advisers can help you weigh up the pros and cons of equity release to help you decide if it’s right for you.

They can also help you assess possible alternatives to help you decide ‘is it worth taking equity release or would an alternative be better?’

For instance, if you require short-term borrowing and a family member could help you out, then perhaps equity release isn’t the best option right now. On the other hand, if you are struggling to pay your mortgage, bills and credit cards every month and can’t see a way out, then equity release could help you to get on top of everything again.

Read more: How could equity release help you?

Speak to the team today

Still have some questions after reading about the benefits and pitfalls of equity release? For professional advice from one of our selected advisers, please call free on 0808 178 3055 or request a call back at a time convenient to you. They will be able to help you assess whether equity release is a good idea for you, including looking at whether there is a better alternative to equity release.