Equity release is a general term for the process of extracting the equity a homeowner holds in their property as cash. This can be achieved in one of two ways – the most common scenario is to use a financial product called a lifetime mortgage, to assume a debt secured against your property – like a mortgage. The homeowner is paid out the value of this debt as cash, and permitted to live in the property until the last homeowner dies or moves into residential care.
The second, much less common type of equity release, is home reversion. This does not involve replacing home equity with debt. Instead, the homeowner sells an equity stake in the home to the equity release provider.
There are other differences between the two products – one of the most important being that while it is possible to qualify for a lifetime mortgage once the youngest homeowner is aged 55, for home reversion this is typically 65.
The lifetime mortgage differs from a traditional mortgage in that, having assumed the debt, there are typically no payments to make in the lifetime of the homeowner, although usually lenders do allow adhoc payments to control the value of the debt. For this reason, the value of the debt can compound rapidly, as interest is added to the balance.
Modern lifetime mortgage products, offered by lenders that are part of the Equity Release Council (ERC), provide safeguards to ensure the value of the debt cannot rise beyond the value of the house, and may in some cases agree to ringfence a portion of the property value, to ensure that a homeowner has home equity to leave as a bequest.
Interest rates on lifetime mortgages are typically 1-2 percentage points above traditional mortgage rates, reflecting the fact that the lender does not know with certainty when they will be repaid. However, interest rates on lifetime mortgages are typically either fixed or capped – meaning the homeowner would not unexpectedly find the size of their lifetime mortgage increasing just because interest rates have risen sharply.
Other safeguards in lifetime mortgages may include stipulations that the homeowner’s heirs be allowed a grace period after the death of the homeowner to pay off the lifetime mortgage, in order to prevent the house being sold.
By contrast, with home reversion, because there will be no payments on the provider’s investment, and the provider will only receive their investment back once the homeowner dies, the provider will offer to purchase a share of the property at a substantial discount to market value – typically around 30-60%, depending on the age of the homeowner.
An advantage of home reversion is that, because there is no debt involved, the provider takes a share of any fall in the value of the property, alongside the homeowner. Of course, if the value of the property rises, the provider also benefits by an equivalent amount.
A qualified equity release advisor will be able guide you further on the difference between equity release and a lifetime mortgage, as well as helping you to find the most appropriate equity release product for your needs and circumstances.