Tempted by equity release - read this first!
You've done it! You've finally reached retirement age and look forward to taking your foot off the gas and relaxing. You might have heard of equity release schemes, but how do you know if they are right for you? Read on to find out more.
Congratulations. You've worked hard for decades, and this new, slower pace of life in retirement is your well-deserved reward.
But, with your retirement from work comes the end of your regular monthly salary. You now have only your pension to rely on. Yes, you could have more than one pension, and you might bring in plenty of money each month to live comfortably, particularly when you have no mortgage to pay out. But, your new-found free time might have opened up conversations about plans - once-in-a-lifetime holidays to explore the world, or perhaps you want to develop your home a little. Maybe the kids are getting married or buying a home of their own, and you want to be able to help them with a lump sum. Often, when hitting retirement age and realising that remortgaging your house probably isn't an option anymore, the conversation turns to Equity Release.
So, what is Equity Release? According to Halifax, Equity Release is a way to unlock the value of your home. If you're 55 or over, you can take out cash tax-free. You can do so without having paid off your existing mortgage; however, this must be repaid from the money you release, and you don't have to move out of your home.
Release cash tied up in your home to spend however you like. And you don't have to move house or downsize! You don't even have to make monthly payments if you don't want to. Sounds too good to be true, doesn't it?
Now, you can enjoy your retirement, go on a round-the-world cruise, and pay for those huge life milestones for your children without dipping into your savings or investments and without worrying about whether your pension will stretch far enough.
But, as with all things that sound too good to be true, there is often a catch. In the case of equity release schemes, the main drawback is compound interest.
If you have savings, you might already know that compound interest can be marvellous. In fact, Warren Buffet is reported to have described compound interest as the eighth wonder of the world. Put simply, when you save money and earn interest on the savings, you also earn interest on the interest itself. As the pot of savings grows, the interest is paid on the total amount, meaning that each month, the interest payment is calculated on the initial savings and the interest paid last month (and all of the preceding months, too).
However, the crucial second sentence often missed in Warren Buffett's famous quote is "He who understands it, earns it … he who doesn't… pays it." Therein lies the major problem with equity release loans. Because that is what it is, a loan. And the interest accrued each month accumulates. If you don't make payments, that interest is rolled up and compounds until you sell the property or your family sells after your death. At this point, whatever amount is owed will need to be paid, and you or your family will be left with a substantially reduced pot at the end.
The amount due to be paid back will depend on a) how much you borrow, b) how long you live after taking out the loan, or c) if you make any monthly payments to keep that interest at bay. If you have enough pension monthly to make the interest payments, you have effectively taken on an interest-only loan. If you don't make any payments, that interest will be rolled up and added to the outstanding amount.
This could mean that if you take out the loan at age 55 and make no payments but live in the same property until you are 100 years old, there is a chance that there will be no equity left in the end.
Of course, there is a place for all of these schemes, and they might just work out for you and your retirement plans, but you must make sure that you are entering the agreement fully aware of the pros and cons before you commit to anything.
If you decide that downsizing your current home would be more sensible for you to release the equity tied up in it, get in touch with our friendly team of property experts to help you.