What Are the Top 10 Pitfalls of Equity Release?
A record £4.8billion in released equity helped over 76,000 customers ease their financial burdens in 2021.
Could you be next?
Before deciding whether it’s the right move for you, read our article and find out what the top 10 equity release pitfalls are so you can sidestep them.
As experts in our field, we discuss the following in this article:
Our experts have exhaustively researched the industry to caution you against the most common disadvantages of equity release.
Our aim’s for this information to equip you with the confidence to make the right decision for your financial future.
Here’s what we’ve found!
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Top Equity Release Pitfalls to Avoid
The top equity release pitfalls to avoid include mounting interest bills and that you won’t benefit from the full value of your property.
You may have heard some horrendous equity release horror stories from your friends.
It’s true, equity release can be a costly exercise if it’s not done right, but if you know what to look out for, then it can be a life-changer.
Let’s run through the most common pitfalls that catch people out.
Pitfall #1: Mounting Interest Bills
If you take out equity release in the form of a lifetime mortgage, you’ll be borrowing money against your home at a fixed rate of interest.
You’re not expected, nor obliged, to make any repayments on this loan until your house is sold, either when you pass away or move into permanent care.
The interest you pay on your principal debt is compounded and will grow at a scary rate because you’re not making any repayments.
Compound interest1 is calculated on the principal debt plus the interest accrued over the loan’s lifespan. So, every time you pay interest, it increases to a more significant amount.
There’s some good news!
One way around this is to take out a retirement interest-only mortgage, a plan that allows you to make monthly repayments that cover the interest portion of the loan.
This means that you’ll only have to pay back what you borrowed at the end of the loan term and not any additional interest.
Pitfall #2: Missing Out on Housing Price Rises
A home reversion plan is the alternative equity release option to a lifetime mortgage. You basically sell part of your home to a provider, and in return, you’ll receive a lump sum – your loan – and the right to continue living in your home for the rest of your life.
When you sell your home, you or your loved ones will only receive payment for the percentage of the home you still own. The provider will collect payment for the portion they own to pay off your loan.
Should there be any increase in your property’s value, you’ll only benefit from it on the portion you still own.
Although you can’t avoid this pitfall with a home reversion plan, you can discuss your options with your equity release advisor and see if there’s an alternative that would suit you better.
Pitfall #3: Limits on the Amount You Can Release
The amount of equity you can release from your home can vary from 20% to 60% of your home’s value.
There are several factors that your provider will consider when agreeing on a loan amount.
- Your age.
- Your general health and lifestyle.
- The value and condition of your property.
- Any outstanding mortgage against your home.
The amount you’ll be able to borrow will depend on all the above factors and be determined on an individual case basis.
Pitfall #4: Spending Money for Nothing
One of the top pitfalls of equity release is taking out more money than you actually need.
It’s human nature to want to feel financially safe and secure. Having a little nest egg ready and waiting is one way of doing this.
The vital thing to realise is that your little nest egg will accrue compound interest with equity release, so the longer it sits there unspent, the more it’ll cost you.
It would be a more financially savvy move to leave the equity in your home until you’re sure that you’ll use it.
A discussion with a qualified adviser will determine the appropriate amount to release to achieve your immediate financial goals.
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Pitfall #5: Releasing Equity When You’re Younger
Once you find out about equity release, it can be like a carrot dangling in front of you. But accessing that money too early could cost you more.
Providers tend to offer older lenders a more significant amount with a better interest rate.
As a result, the younger you are, the less you’ll be able to release and the more interest you’ll have to pay back.
It pays off to wait a little longer before jumping into equity release, as tempting as it might be to get your hands on that cash.
Pitfall #8: Early Repayment Charges
An early repayment charge2 is there to deter you from doing precisely that. It’s put in place to safeguard providers should you wish to repay the loan before your term ends.
These charges typically fall between 1% and 5% of your loan and will usually be based on how far into your loan term you are.
Luckily, with competition increasing in the equity release market, providers are becoming more flexible and have started offering repayment options.
Some providers now allow you to make payments after a set number of years, while others will enable you to pay a percentage of your loan or interest off every month.
Discuss the options with your equity release advisor to find the best plan for you.
Pitfall #8: The “Setup & Forget Catch”
Once you set up an equity release plan, it’s easy to forget about it. To be honest, it hardly ever crosses one’s mind to review the plan and its competitiveness in the market.
With an ever-changing market, providers and their plans have to evolve to keep up with the times. This often means introducing new plans, lower interest rates, and better features.
It’s well worth reviewing your plan with your equity release advisor every few years to avoid being stuck with a one that’s costing you more than it should.
Pitfall #9: Affects Your Benefits
More often than not, borrowers are oblivious to the effects that releasing a large sum of money could have on their benefits.
Your capital and income determine your eligibility for state benefits3 in the UK. So, if you release a lump sum of money from your home, your income and capital go through the roof.
This often disqualifies you from being able to claim means-tested benefits.
One way around this could be to look into a drawdown lifetime mortgage which enables you to access the money in your home through a reserve facility.
Instead of receiving the entire loan as a lump sum, you’ll be able to dip into your reserve when you need it, often keeping your means-tested benefits intact.
Pitfall #10: Reduced Inheritance
Equity release can significantly impact any inheritance you plan on leaving behind for your loved ones.
Typically, when you pass away or move into long-term care, your home will be sold, and the proceeds will then be used to pay back your equity release loan and the interest accrued.
If you opted not to make any repayments before the sale of your home, then the chances are your estate will owe a substantial amount of interest on the initial loan.
Your heirs will only inherit what’s left of your estate after your equity release provider has recouped their money.
It’s not all bad, though!
These days, many providers offer an inheritance protection guarantee.
This enables you to section off a portion of your home’s equity for your loved ones when your home is sold.
Despite These Pitfalls, Is Equity Release a Good Idea?
To answer the question ‘is equity release a good idea?‘ you’ll need to chat with a financial advisor who’ll look at your circumstances.
After all, each case is different.
Despite the Pitfalls, Why’s Equity Release Popular?
Equity release remains popular despite the pitfalls because there are ways around them, and older borrowers can safely access the cash tied up in their homes.
With the Equity Release Council setting standards in the market, consumers are protected by features such as:
- No-negative equity guarantee.
- The right to make penalty-free payments.
- Inheritance protection guarantee.
Why Should I Still Consider Equity Release, Given the Pitfalls?
Despite the pitfalls, you should still consider equity release, as it can provide a financial lifeline for you in retirement.
The money released can ease the burdens of day-to-day living during retirement, fund a dream holiday, or pay for home renovations. It can be spent however it’s needed.
Are There Better Alternatives to Equity Release?
Better alternatives to equity release could include:
- Borrowing money.
- Taking out a personal loan.
- Finding additional or alternative employment.
- Claiming state benefits.
Only an in-depth discussion with a qualified equity release adviser can determine whether the above alternatives are better for you than equity release.
Is Releasing Equity a Bad Idea?
Releasing Equity can be a bad idea if you don’t receive advice from a qualified advisor or ensure the provider you choose is a member of the Equity Release Council.
Some negatives include:
- Compound interest
- Affects on benefits
- Reduced inheritance
Get professional advice from a qualified adviser, and you’ll be able to determine whether it’s a good fit for you or not.
Equity release is a popular form of borrowing, but it doesn’t come without risks.
But with the right advice from a qualified adviser, you can avoid these traps and find a way around them.
Having read the main equity release pitfalls above, the decision is ultimately yours.
Make sure that you’re armed with the knowledge to make the right one.
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Editorial Note: This content has been independently collected by the EveryInvestor team and is offered on a non-advised basis. EveryInvestor may earn a commission on sales made from partner links on this page, but that doesn’t affect our editors’ opinions or evaluations. Learn more about our editorial guidelines.