Alternatives to Equity Release
Equity release is an appealing option to free up cash locked in your home. But there can be various downsides which mean it may not be the best solution. So we’ve asked Tembo Money to tell us about the alternatives to equity release to help you make the right decision.
June 21, 2022
6 minute read
Many people over 55 turn to equity release for various reasons – to pay for home improvements, consolidate debt, or even gift to children as an early inheritance. It can also be helpful to bolster low pension income. Put simply, equity release is a loan secured against the value of the property that needs to be paid back when the occupier either goes into permanent care or dies.
How does equity release work?
Equity release works in a similar way to a mortgage, however the lender is paid back when the house is sold (usually when the occupier dies). Equity release is only for those aged 55 or over and tends to work best for those who have built up lots of equity in their property, but have low income. When the lender decides how much the occupier can borrow, they take into account age, how much the property is worth and the state of the occupier’s health. The occupier can typically borrow up to 60% of the value of the property.
Pros and cons of equity release
Equity release can be a great solution for people looking to access additional funds without needing to leave the family home. One of the main reasons people like the idea of an Equity Release product is that there are no monthly payments. For some people this suits their needs perfectly.
However, there are downsides to equity release that may leave you looking for alternatives:
– You pass on less inheritance
As equity release is a loan secured against the value of your property, the loan is paid back to the lender with the property’s remaining equity. As the interest on the loan compounds over time, the loan size you need to pay back to the lender when you die could become significantly larger, particularly if you take out the loan when you’re younger. There could be instances where the amount owed ends up being almost the same as the equity in the property – meaning that loved ones could stand to inherit very little.
– Equity release can be expensive
The interest rate on the loan is secured for the entire period (usually between 2% – 5%). This means that the interest rolls up over time making the final payment expensive. Alongside this, any early repayment can incur penalties of up to 25% of the original loan amount.
What are the alternatives to equity release?
Use a Retirement Interest Only mortgage
A Retirement Interest Only mortgage (RIO) is similar to equity release, however, there’s a key difference. With a lifetime mortgage (the most popular form of equity release) the occupier pays no monthly payments as the interest compounds over time and the final loan is payable at the end of the term. This means that there is a larger sum to pay at the end of the mortgage term. With a RIO, the occupier makes monthly payments to pay the interest generated on the loan. This means that when the home is sold, or the occupier moves, only the lump sum borrowed is paid back. This leaves more value in the property, and therefore more inheritance that the occupier can leave to their family.
If you want to repay some of the debt when you have spare cash, you can pick a deal that allows overpayments. And if you have an unexpected windfall in the future and want to clear the debt entirely, most lenders will let you pay back the mortgage penalty-free after your mortgage deal has expired.
Let’s take a look at an example.
Say you want to help your child buy their first home, but you don’t want to downsize, or use your cash savings to gift them a deposit. Using a RIO mortgage, you unlock £10,000 from your £400,000 property. As you are paying the interest off the loan, you pay £22 a month* over the term of the mortgage (which will end when you leave the property). When you do leave the property, you will only owe the original £10,000 that you borrowed, which is repaid to the lender before the remaining equity is calculated.
Tembo specialises in later life lending products, such as RIOs. Most commonly, Tembo uses them in conjunction with their Deposit Boost service, however they can be used for a variety of reasons. To see how Tembo could help you with a RIO, visit our site or get in touch.
Retirement Capital and Interest mortgages
A Retirement Capital and Interest (RCI) mortgage is like a traditional mortgage because it has a fixed end date and you repay the debt as well as interest. The main benefit of an RCI deal is its flexible upper age limit based on your life expectancy. An RCI mortgage is ideal for homeowners with a generous pension income who want to remortgage but exceed the maximum age of a traditional mortgage.
Borrowers must be aged 55 and over. You’ll be able to borrow around 50% to 60% of your property’s value. The debt should be fully repaid before you die which means you can pass on your home as an inheritance.
When you are looking to raise capital, downsizing could be an option to consider. Moving to a cheaper area, or just a smaller sized property, could provide a vital cash injection if you need to supplement your retirement. Downsizing could also be useful for saving on the property in other ways, such as on Council Tax, running costs and maintenance. However, there are costs to moving property (for example, paying stamp duty when you buy a new property, and paying any fees for legal work and property surveying). Selling a property can also take time, so if you need cash quickly, it might not be the best option.
Remortgaging to release equity is a way to get access to a cash lump sum. Remortgaging typically happens when homeowners come to the end of their current mortgage deal and want to get a new deal, however you can also remortgage to borrow more money. This means you can add additional borrowing to your existing mortgage. As with equity release and other retirement mortgage products, remortgaging means that you could stay in your property, rather than downsizing. However, increasing your mortgage will almost always increase the overall cost of the mortgage, as well as your existing monthly payments. If you are over the age of 60, lenders may be reluctant to let you increase your borrowing.
Get in touch with Tembo to organise a remortgage.
Taking money from a flexible pension
Otherwise known as a pension drawdown, flexible retirement income is a way of taking money out of your pension pot into retirement. It gives you more flexibility over how much of your pension you can receive. So, if you need an injection of money, you can take up to 25% of the pot as a tax free lump sum, whilst the reminder remains invested. This gives it the potential for investment growth. However, it is important to monitor your withdrawals and pension growth so you don’t run out of money for the future. If you are unsure about how this would affect your finances in the future, we would suggest speaking to a financial adviser or your pension provider, before using this as an option.
Use other savings
Many people find it preferable to use savings rather than diving into their pension pot when planning for retirement. This is because if you have a private pension pot, any remaining money in the pot is exempt from inheritance tax. This means more money can be passed to family when you die, compared to money gifted from savings.
A Lifetime ISA (LISA) might be a good way to save for your retirement in conjunction with your pension. Whilst LISAs are more commonly used by those looking to save for a house deposit, you can also use it to save for retirement – the government still tops up the account with 25% of what you’ve saved, and you can access it without any penalties from the age of 60. Any money you withdraw from a LISA doesn’t count as income, which means it isn’t taxed. However, the maximum you can pay into your LISA is £4,000 a year, or £128,000 over your lifetime.
Tembo are the UK’s Best Mortgage Broker, and are experts in Retirement mortgage products. Get in touch with them today to start the advice process and learn more about these specialist mortgages.
*Based on a Retirement Interest Only mortgage on a 2.59% interest rate. This information is a guide only and should not be relied on as a recommendation or advice that any particular mortgage is suitable for you. You should make an appointment to receive mortgage advice which will be based on your needs and circumstances.
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