Equity Release

How does equity release work?

You may also find that there are other imaginative ways to generate an income from your property without leveraging yourself up with debt.

Remember a granny annexe or small outbuildings suitable for conversion could be let out as holiday accommodation, providing useful extra income. Houses with very large gardens are also a great long-term bet if you can get planning for a garage with office space above. This could either be subsequently let for income as it is, or possibly converted to more valuable living accommodation.

That's good advice. But I don't think my garden shed is going to make me rich. Tell me more about these schemes.

Well, at present there are three types:

Under roll-up mortgage schemes the provider lends the customer cash and takes a mortgage charge over the property. The debt is eventually repaid when you die. These schemes account for about 90 per cent of the present market. Interest is compounded monthly or annually, usually at a fixed percentage rate, and this is added to your original loan, so your residual equity share in your home is likely to fall over time.

Fixed lifetime mortgages set the level of debt at the outset and you benefit from any increase in the house value. The debt never increases, so it looks high in the early years but the longer you live the greater your share of the equity capital in the house, assuming property prices continue to increase.

Finally under reversion schemes the provider buys a share (or all) of your property. This purchase price is discounted (for example they might pay £30,000 for a 60 per cent share in a £100,000 house) to reflect the fact that the provider will not be able to take its share of the house value until you die. The longer your life expectancy the less they will pay for a share of your house.

This is all rather complicated isn't it?

Each scheme has its merits and drawbacks so you need to balance your immediate needs with your longer-term objectives. Inevitably you will have to compromise between extracting equity from your home and passing on wealth to your family when you die.

Beyond this you need to decide which risks you are prepared to take, for example how important is it that you know the value of the mortgage at the outset? Are you comfortable with the fact that if you live longer or shorter than average this might affect the final amount that you owe the equity release provider. And if you want to draw occasional lump sums, for example, then you will need one of the new fixed lifetime mortgages that offer this facility.

I don't want to depress you but what does happen when I die?

Your home is sold and the debt repaid to the equity release company. Any remaining capital forms part of your estate.

This all sounds a little scary. Who's looking out for me to make sure I'm not mis-sold?

The Financial Services Authority, the chief watchdog, started to regulate residential mortgages in October last year. Reversion schemes will come under the FSA's watch shortly. In addition, members of the Safe Home Income Plans (SHIP), a self-regulatory body, guarantee certain features. The most important of these is a “no negative equity” guarantee, so the amount you owe will never exceed the value of your home. Because of safeguards such as these, some advisers recommend consumers only look at SHIP-approved products.

But you will also need to look at other factors such as your age and how much you wish to borrow off the back of your home. These factors are likely to further narrow the field of companies offering a suitable equity release product.

Is there anything else I need to worry about?

If you qualify for any means-tested benefits, any additional income you generate from your home could affect these. You should take advice.

As with private pensions, the interaction between state benefits and equity release is complicated, and the Institute of Actuaries has called on the government to disregard equity release capital, so that pensioners do not lose access to pensions credit and council tax benefit, for example.

And what happens if I want to move?

Many people need to move in later retirement, for example into a smaller house, sheltered accommodation or into care. If you go for equity release make sure you can transfer the mortgage and that there will be no penalties should you terminate the scheme.

This all sounds like something that involves the whole family. Should I tell them what I'm doing?

Providers and advisers think it's a good idea because your family will have to sort out your house sale and repay the debt when you die. Also, although you may think you are letting your children down by reducing their inheritance, in practice you will probably find they are pleased that you will have adequate financial resources in retirement.