Lifetime mortgages are a very unusual type of debt, in that there are no mandatory interest payments or other debt servicing costs during the term of the loan. All interest is rolled up and added to the value of the loan to be repaid. Because there are no payments being made, interest then compounds rapidly. For this reason, the Equity Release Council has standards that prevent the value of a lifetime mortgage from growing larger than the value of the home it is secured upon.
Lifetime mortgages are a popular equity release product for the over-55s, that allow homeowners to withdraw some of the equity tied up in their home as cash. The homeowner pays for this with a mortgage secured on the property that will not be repaid until the death of the homeowner, or their move into residential care. They are sometimes called reverse mortgages outside the UK, as they reverse the normal mortgage process.
Since the balance can increase rapidly, homeowners are usually allowed to make ad hoc payments to their lifetime mortgage or control the balance of the loan. These will usually be stated as a maximum percentage of the loan principal value and the accrued interest per month. Another way to control the balance of the loan is to use a drawdown lifetime mortgage, where the balance of the loan is drawn down piecemeal as needed. This means that the borrower doesn’t pay interest on the loan until the money is required.
We have discussed ordinary roll-up lifetime mortgages, where interest is added into the balance. It is also possible to apply for interest only lifetime mortgages, where there is a contractual obligation to repay the interest on the loan each month. This locks the borrower into monthly payments, but it means that the loan to be repaid by the borrower’s estate will be only the nominal amount originally borrowed, assuming all interest payments have been made. Interest only lifetime mortgages are typically fixed rate, and have the advantage that if the homeowner can no longer make payments for any reason, the product can effectively become a roll-up lifetime mortgage from that point forward.
Interest rates will typically be 1-2 percentage points higher on a lifetime mortgage than a standard residential mortgage, because the lender is bearing greater interest rate risk (as the principle of the loan is not repaid and interest compounds) as well as property price risk (as your home could decline in value and the mortgage cannot be greater than the value of the home). However, interest rates are almost always fixed for the whole term of the loan. It is possible to obtain a variable rate lifetime mortgage, but this is usually discouraged, as high interest rates could lead to the value of the debt compounding rapidly. The Equity Release Council requires that variable rate lifetime mortgages are capped at a specified level.
To find out more about how interest works on lifetime mortgages, and whether equity release is the right option for you, it is wise to consult a qualified equity release adviser.
