How can releasing equity from your property assist with the rising cost of living?
It won’t have gone unnoticed that the Bank of England Monetary Committee recently increased the base rate again, which now stands at 5.25%, in an attempt to curb inflation. This is the fourteenth consecutive rise in the base rate in 19 months and has put the rate at the highest level since 2008. There is the possibility that we haven’t hit the peak of the base rate increases just yet.
Homeowners will continue to be affected by rising interest rates, with those on standard variable and tracker mortgages seeing an immediate increase in their monthly costs.
Those with fixed rate mortgages coming to the end of their fixed terms will find that the new fixed rate offerings are significantly higher, so their monthly costs will also go up, and by a lot.
This further rate hike will hit more homeowners hard, which has been recognised by the Government.
The Chancellor is aware of the hardships these continual interest rate hikes will cause to some. Under a new agreement, all mortgage borrowers with regulated firms who are up to date with payments but struggling, will be able to move for six months to paying only the interest. Or they can extend the mortgage term in order to lower repayments. This will, however, only assist in the very short term.
Older borrowers who have fixed regular cash flow coming in to cover their core expenditure, including mortgage repayments and discretionary expenditures, with no access to additional funds will be particularly impacted. Very simply, they may not be able to afford the new increased monthly mortgage repayments in both the short and longer term. In addition, they may struggle with other essential costs, such as electricity and food, which have also gone up significantly and are already eroding any financial buffers they have.
Borrowers could consider downsizing which may provide funds to fully repay existing mortgages or reduce the amount of mortgage to provide manageable repayments. From experience, however, I find that many homeowners would prefer not to move and want to remain in their home.
How a Lifetime Mortgage can help?
A Lifetime Mortgage, the most popular type of equity release arrangement, could be considered by homeowners aged 55 and over and struggling to make mortgage repayments.
Unlike a standard mortgage, most Lifetime Mortgages don’t require you to make monthly repayments. In fact, the loan will not need to be repaid until the homeowner dies or goes into long term care. In the case of joint homeowners, the loan will not need to be repaid until the second homeowner dies or goes into long term care. When this happens, the loan plus interest is repaid in full – usually from the sale of the property.
With a Lifetime Mortgage, there are no affordability checks done when taking it out as there isn’t a requirement to service the interest, though you can service some or all of the interest if affordable and you would like to. A Lifetime Mortgage is flexible as you can service the interest in one year and not the next if you so wish. By not servicing the interest on a Lifetime Mortgage, the interest will compound which can be significant over time.
Interest rates on Lifetime Mortgages are, like conventional mortgages, higher than they were a year or so ago. Interest rates on Lifetime Mortgages are fixed for the homeowners’ lifetimes, so you will know from outset how the borrowings will accumulate over time if no interest is serviced.
The amount you can release when taking out a lifetime mortgage is dependent on your age (youngest age for joint homeowners), the value of your property, and some lenders might offer higher releases to those with certain past or present medical conditions. The amount you can release increases with age.
It is advisable only to take an initial release of the amount you need to use in the short term as you can include a reserve facility which enables easy access to further monies through the same lifetime mortgage as and when needed in the future. No interest is payable on the monies held in the reserve facility until such time as the monies are taken. This will help limit the compounding effect of the interest if you choose not to service it.
The inclusion of a reserve facility can result in a slightly higher fixed interest on the initial release taken, but this is not always the case. Monies held in the reserve facility can be taken in chunks - all at once or not at all if never needed. The interest rate on any monies from the reserve facility will be fixed for your lifetime at the lender’s prevailing interest rate at the time.
You will continue to own the property when you take out a Lifetime Mortgage so you, and ultimately your beneficiaries, will benefit from any increases in the property value.
Lifetime Mortgages typically have early repayment charges in the first 8 to 15 years of taking them out. There are however a number of scenarios where the early repayment charge won’t apply, including if you downsize and transfer the Lifetime Mortgage onto your new property. Any amount the lender requires you to repay on downsizing, due to a lower loan to value, can be repaid from the surplus sale proceeds without an early repayment charge applying.
Additionally, if interest rates come down in the future, you may be able to switch to a plan with a lower fixed interest rate without any early repayment charge being imposed by the lenders, as long as you do this after the early repayment period has elapsed. We would explore the best offerings for you and attend to the switch if considered in your best interests to do so.
Lifetime mortgages could impact on any means tested State or local authority benefits you receive, so it is important to consider these when considering a Lifetime Mortgage.
What is a No Negative Equity Guarantee?
Years ago, equity release arrangements had a poor reputation. However, now with the introduction of improved features on Lifetime Mortgages, including a No Negative Equity Guarantee and fixed interest rates, equity release is playing an increased role in effective later life planning. A No Negative Equity Guarantee provides protection so that when the borrowings are repaid to the lender on death or long-term care, you can never leave a debt that is larger than the value of your property, even if your property has fallen significantly in value.
What are the downsides of taking out a Lifetime Mortgage
- The initial release will increase if the interest is not serviced and be rolled up which means the amount you owe on your Lifetime Mortgage grows every year.
- Choosing equity release may affect you in the longer term. You need to be sure that the arrangement suits you both now and in the future. For example, equity release can make it hard to move. If you decide you want to downsize later on you may not have enough equity in your home to do this.
- Interest rates on Lifetime Mortgages are generally higher than on conventional residential mortgages.
- Releasing equity from your home may affect your eligibility for state benefits, grants or allowances.
- If you release too much equity from your home, you may find you do not have the money you need later in your retirement. For instance, to pay for long term care.
- There may be substantial early repayment charges if you decide to voluntarily repay the monies released typically within 8 to 15 years of taking out a Lifetime Mortgage.
Other possible uses of Lifetime Mortgages
Lifetime Mortgages are not only useful for those struggling with conventional mortgage repayments, but they can also be used in the following scenarios:
- If you want to free up capital to help your children or grandchildren get a foot on the property ladder or to assist with other expenses including school fees.
- If you need some capital for home improvements and would prefer not to touch your more liquid assets, such as your savings or investments. This way your regular cash flow will not be adversely impacted. This assumes you don’t qualify for local authority grants for home improvements which should be explored in the first instance.
- If you or your spouse don’t qualify for NHS, State or Local Authority funding assistance and you need more funds available to pay for comprehensive and often expensive care at home.
- As part of an inheritance tax mitigation strategy where you gift the monies released on to the next generation. This could provide a very valuable saving to inheritance tax after 7 years and possibly from the end of year 3 depending on the amount gifted.
- To top up your pension income or take less cash flow from your pension plans. Following the introduction of Pension Freedoms there is also the argument to take less money out of pension plans now which are typically inheritance tax free and instead use equity from your property.
A Lifetime Mortgage isn’t for everyone and we always consider every individual’s personal circumstances to ensure we recommend the most appropriate solution for them.
Switching a conventional mortgage to a Lifetime Mortgage, or taking out a Lifetime Mortgage could, in some situations, be life changing for some homeowners and mean they no longer have to worry about making monthly repayments. Instead, they have more money in their pockets to do what they would like to do, including the simple things in life.
Taking out a Lifetime Mortgage and not servicing the interest will though reduce your estate that can pass on to your beneficiaries when you die or move permanently into long term care when the property is typically sold.
How equity release has changed a homeowner’s life for the better
I would like to share with you the very first equity release I advised on some years ago. I met with a lovely lady and her neighbour as she didn’t have any family. She wanted to release some money from her property to cover the costs of an inside toilet installed as she only had an outdoor one and she didn’t have the funds to pay for this. She also wanted some additional monies for discretionary expenditure. We established that she wasn’t entitled to any local authority assistance. The equity release was done using a Lifetime Mortgage and around 3 months later, the lady called me to say the new toilet was installed and she said I had changed her life. I was delighted that my advice had made such a difference to her.
You only get one life - my motto is to make the most of it while you can. But it is important to make sure you have a financial plan in place and always consider both the advantages and disadvantages of actions to be taken.
If you would like independent financial advice on equity release or general financial planning, please do get in touch, please give us a call on 0333 323 9065 or book a free non-committal initial consultation with one of our chartered advisers to find out how we might be able to help you.
Note: Equity release is a lifetime mortgage. To understand the features and risks, ask for a personalised illustration.
This article is for information only and does not constitute individual advice.
The Financial Conduct Authority (FCA) does not regulate estate planning or tax advice.