Everyone is aware of what a residential mortgage is, how it works and what its function is. Primarily, a residential mortgage provides valuable funds that bridges the shortfall between the property purchase price & the deposit saved by the intended mortgagor. These mortgage funds are then sent at the end of the legal process to assist with the house purchase.
I always state to my clients that equity release is only a form of mortgage itself, and actually when it comes to purchasing a property, equity release works in exactly the same way as a residential mortgage…It provides a capital lump sum to bridge any shortfall and is added to the purchasers deposit to ensure it facilitates the property purchase. However, how the equity release scheme functions thereafter is down to the type of plan selected.
When it comes to equity release, there are two different sorts of products available – the lifetime mortgage and the home reversion scheme.
Lifetime mortgages are the most common type of equity release scheme accounting for over 99% of all plan written. They act in a similar way to a standard mortgage, in the sense that the property acts as security for the loan, and the capital amount is paid back when the homeowner dies. There are two types of these mortgages – the ‘roll-up’ lifetime mortgage and the ‘retirement’ mortgage.
The ‘roll-up’ mortgage refers to the fact that the interest is rolled-up and added to the original amount of the mortgage over time. This means that the longer the mortgage is held for, the greater the amount of interest that is paid back when the mortgage-holder dies. This is due to the compounding of the interest each month, or year.
The second type is the ‘retirement mortgage’ – this is more like a standard mortgage, where monthly repayments are made but there is no redemption date. These require monthly payments and like a traditional mortgage, the amount that can be borrowed is based on income into retirement. Lenders have been risk averse with lending in retirement since the credit crunch.
Home reversion schemes are much less common and involve the homeowner selling 100%, or a proportion of their home in exchange for a regular income or lump sum, together with the right to remain in the property until they die. When they do pass away, the property is sold and the value achieved is split as per the proportion owned. For example, if a 40% share was sold, then the occupant’s estate would receive only 60% of the final sale price. These schemes have received some criticism, as the private company benefits as much as the original owner from any increase in the property’s value. However, they are fully regulated & advised by FCA qualified advisers. They will ensure that all pros and cons are discussed, so the full implications are brought to the homeowner’s attention before they decide to proceed.
So what can equity release be used for? As well as to raise funds to pay for home refurbishments, buy a new car or to help out children with their finances, an increasingly popular use is to actually use the equity in one property to buy a second property – perhaps a holiday home or a second property to leave to children. Whether that’s in the UK or abroad is irrelevant; equity release can provide universal solutions in retirement