Equity Release Loan Scheme Choices

Two types of equity loan scheme are available: lifetime mortgages and home reversions.The Financial Services Authority (FSA) regulates lifetime mortgages. Home reversion schemes are to be regulated by the FSA from April 2007.The FSA is a non-governmental body that regulates all providers of financial services in the UK.

Lifetime mortgages

Lump sum scheme

The lender will lend you an agreed tax-free amount of money based on your age and value of your home. Nothing is repaid until the property is sold, but interest is added to the amount you have borrowed each year.This interest is ‘rolled up’ over the period of the equity loan and repaid in a lump sum, together with the amount borrowed, when the property is sold. The remaining proceeds are then paid to you or, should you die, will form part of your estate. Because of the unknown period of the equity loan the amount of the final debt cannot be guaranteed and the outstanding equity loan debt, including the added interest, can grow substantially.

Income scheme

The lender will give you an agreed tax-free monthly income for the rest of your life based on your age and value of your home. Nothing is repaid until the property is sold, but interest is added to the amount you have borrowed each year. As in the above lump sum option the interest rolls up, is repayable with the equity loan and the final debt cannot be guaranteed. However, the debt will grow much more slowly with this type of equity loan because interest is charged only on the amount you borrow at the time and consequently the interest charged over the life of the loan should be lower than if you were to take a lump sum at the outset.

Draw-down loan scheme

The lender will make a maximum loan facility available to you for a predetermined period or for your lifetime.Within certain limitations, this facility allows you to ‘draw’ on these funds tax-free as and when you require them, with the advantage that you pay interest only on the amounts you withdraw. Repayment of the draw down loan and interest is as for the lump sum and income options.

Protected equity loan scheme

This option allows you to ensure that the debt will not grow to more than an agreed percentage of your property value, ensuring that, for example, you will have a guaranteed percentage of your property to leave to your beneficiaries regardless of what might happen to property values in the future.

Fixed option equity loan scheme

This type of contract offers a known repayment figure from the outset. It is not affected by the life of the equity loan or by how long you live. As well as being a potentially cheaper option for many people, it allows you to know exactly where you stand financially. However, if you are in poor health or expect to have to sell the property in the future, this option can be more expensive if the loan is repaid very early.

Interest rates

Lifetime mortgages can be taken on either a fixed rate or a variable interest rate option. A fixed rate is set at the outset, is guaranteed for the life of the mortgage and will not alter.With a fixed-rate scheme it is possible to project the increase in debt for your estimated life expectancy. A variable rate may be a cheaper option today but, as the name suggests, it could increase or decrease during the life of the loan. The rate is dependent on external conditions such as movements in the Bank of England base rate, so it is not possible to project the eventual size of the debt over the lifetime of the loan.

With a ‘draw-down’ scheme the initial amount taken is based on a fixed rate of interest. Future amounts taken will also be on a fixed rate basis but usually at the prevailing fixed rate available to new borrowers at the time the funds are taken: for this reason the rate cannot be guaranteed or the final debt calculated at the outset.

‘No negative equity’ guarantees

The longer you live in a home on which you have a lifetime mortgage, with compound interest, the greater will be the final debt. A ‘no negative equity’ guarantee ensures that the final debt will not exceed the value of the property when it is sold. Without such a guarantee the debt could exceed the property value. It is important to remember that although house prices have risen steadily in recent years, values can also fall and you must not ignore the possibility that even with a ‘no negative equity’ guarantee your equity loan could match your property’s value, leaving nothing for an inheritance.This scenario could also mean that you may find it difficult to move home should you decide to do so at a later date.

The effect of house price inflation

With a lifetime mortgage you retain full ownership of your property, and if the value of your home increases you may be able to benefit from any such increases, releasing more equity if it is needed.The graphs on the right illustrate the effect house price inflation could have on the value of your home compared to the lifetime mortgage outstanding.

Home reversion schemes

Under this type of scheme you agree to sell a percentage of your property to a home reversion company in exchange for a tax-free cash lump sum and guaranteed lifetime lease (this gives you the right to remain living in the property until it is sold after yourdeath, or move to another property or into a care home). The amount you receive will not reflect the full market value at the time you take out the scheme. Instead, the full market value is discounted based on your age, health and anticipated life expectancy.The home reversion company discounts the value of the property because it will not get its money back until the property is sold. It is also taking on a risk with future house prices, which could go up or down. Home reversion schemes can be set up on a lump sum basis or effectively on a draw-down basis, providing the flexibility for you to sell further shares of your property in the future.

No interest or monthly payment is required with this type of scheme.When you die, the percentage of your home that you sold belongs to the home reversion company. The rest will pass to your estate so that you can guarantee to leave a portion of your property in this way, whatever its future value. However, after selling a percentage of your home you will no longer benefit fully from any property price growth. A home reversion scheme is not suitable for short-term borrowing. If you needed to end a scheme early you would have to buy back the home reversion provider’s share of your property at its full market value.This could cost you much more than you received as a cash lump sum.