Many will have heard the term ‘equity release’ before, but fewer people will be familiar with the term ‘lifetime mortgage.’
In practice, the two terms are often used interchangeably. A lifetime mortgage is by far the most common form of equity release. The other form of equity release is a ‘home reversion’ plan, which are rare nowadays.
The purpose of this article is to shine a light on lifetime mortgages, outlining how they work, why someone might want one, and what the potential downsides are.
What is a Lifetime Mortgage?
A lifetime mortgage is a type of secured loan, where the borrower is loaned a lump sum for which the lender takes a legal charge over the borrower’s property as security for the loan. In this sense, it is much the same as any other type of mortgage, although there are some important differences:
- You must be a minimum of 55 years old to take out a lifetime mortgage.
- The interest rate is fixed for life, unlike most fixed rate mortgages which are most commonly two, three or five years.
- The term is open ended. The mortgage will run until the last borrower (if a joint-names mortgage) has either died or entered long-term care permanently. However, the property can be sold voluntarily, and the loan repaid earlier if desired. This may involve paying early repayment penalties, which are explored further below.
- No compulsory monthly payments. Usually, the monthly interest will be added to the total sum owed and ‘rolled up’ over time, with the debt being repaid in full when the mortgage ends and the borrower’s property is sold. Whilst this is commonly what occurs, regular monthly or lump sum payments can be made during the borrower’s lifetime if preferred.
- A lifetime mortgage can be arranged for either a new purchase or a re-mortgage of your existing property.
- A lifetime mortgage is for residential property in many cases, rather than buy-to-let properties.
All the above features are based on current market conditions, which are subject to change.
How much can I borrow?
Lifetime mortgage lenders will not be assessing borrowing capacity based on earned income, expenditure, and credit history, as would be the case with any other type of residential mortgage. A lifetime mortgage will be granted based solely on the age of the borrower and the value of the property in question. The exact percentage of the property value that can be borrowed will differ depending on the lender. As a rule of thumb, though, the older the borrower, the more that can be borrowed.
Unlike traditional mortgages, there is no requirement for regular monthly payments to be made. The expectation is that the loan will be repaid from the future sale of the property upon death, entry into long-term care or an earlier sale.
Is Equity Release a good idea?
The motivations for borrowing money via a lifetime mortgage may be as broad and diverse as the people looking to borrow it. A legal and legitimate purpose will generally be acceptable for personal (not commercial) use, however some common examples include:
Releasing money to make improvements to your home.
Repaying an Interest-Only Load
Interest-only mortgages were quite common, particularly during the 1990s. As such there are many borrowers today coming to the end of their terms. You may be faced with the prospect of having to sell your long-term family home if you do not have cash or other assets which would allow you to repay the original loan. A lifetime mortgage can offer you a convenient way of refinancing the debt and allowing you to keep your home.
With a lifetime mortgage, you remain the legal owner of the property throughout your lifetime, unlike a home reversion plan which involves you selling your property to a lender and effectively becoming a tenant in your own property. This largely explains the rarity and unpopularity of home reversion plans today.
Income in Retirement
You may feel you have insufficient funds to meet your essential everyday expenditure on food and bills. Or you may feel you simply want to release equity to enjoy the equity that you have built up. Whatever the situation, releasing equity to supplement retirement income is quite common. Some lenders allow a ‘drawdown facility’ to be established, where the borrowing can be taken in stages over time for this purpose. This allows you, the borrower, to control what is borrowed and when. The upside is that no interest is incurred until funds are withdrawn. The interest rate applicable to new borrowing will be whatever is on offer at the time, not the fixed rate for the initial borrowing.
Gifting Money to Beneficiaries
You may wish to help a child looking to purchase a home, and release money from your own home to do so. Additionally, your beneficiaries may have an inheritance tax liability when you die as it stands. As such, releasing equity and gifting it to them in your lifetime could help to mitigate the inheritance tax liability.
What are the disadvantages and risks with a Lifetime Mortgage?
A lifetime mortgage can be an ideal solution for many, although there are important risk considerations when deciding whether a lifetime mortgage may be right for you.
Here are some of the mostly commonly cited drawbacks:
Owing to the fact no regular monthly payments are made in many cases, this means interest will compound over time. You incur interest on the previous year’s interest, meaning long-term costs are higher than with a typical mortgage.
For example, if £100,000 was borrowed at a rate of 5%, the interest in year one would be £5,000, which is added to the original sum borrowed. In year two, the interest accrued will be 5% of £105,000, which would amount £5,250. So, you can see how over a longer term the accrued interest will increase year on year.
Interest rates will vary depending on market conditions at the time of application, but they will be fixed for life once the funds are borrowed.
Uncertainty of Final Costs
It is not possible to know when you, the borrower, will pass away in future. It is therefore not possible to know for how many years the compounding interest dynamic outlined above will continue. As such, you need to be comfortable with this element of unpredictability if taking a lifetime mortgage. However, it is possible to make interest payments voluntarily if this is a cause for concern, although in many cases this will not be necessary or advisable. Future increases in the property’s value can help to offset some of the interest incurred. On the downside, depreciating property values will increase the level of debt relative to the property’s value.
Impact on Inheritance
Following on from the above two points. The total amount of interest to be repaid from the sale of the property will mean that the beneficiaries to your estate will need to repay this debt before any inheritance can be received. This is particularly impactful if you’re somebody whose total assets would be within the inheritance nil rate band (£375,000 per person, plus £125,000 for residential property in the current 2023-24 tax year) which is the value of your assets on death on which no inheritance tax will need to be paid. The current rate of inheritance tax is currently 40%.
Long-term Early Repayment Charges
A lifetime mortgage has a fixed-interest rate for life which entails early repayment charges being applicable for an extended period. As such, you should consider future plans such as the likelihood of wanting to sell the property and downsize. Premature repayment of the mortgage could be costly.
It is possible to ‘port’ lifetime mortgages – taking the mortgage with you to a new property if downsizing. In such a scenario, the mortgage will not need to be repaid and no charges incurred. However, this does depend on the available equity in the property and the value for the property you are downsizing too.
Many lifetime mortgage products today also have a ‘downsizing protection’ feature, meaning early repayment charges can be waived if downsizing in certain scenarios. Nonetheless, a lifetime mortgage should be viewed as a long-term commitment by nature, and not a short-term solution.
Given some of the potential risks outlined above, it is advisable to consider other avenues for capital raising first before committing to a lifetime mortgage. Could you downsize to release equity? Do you have other assets which you could utilise before borrowing against your home? Would a family member be able to offer financial support? Could you afford to take a personal loan if the capital required is small enough?
Arranging a Lifetime Mortgage
If after considering the points above, you feel you could benefit from a lifetime mortgage, you will need to contact a financial adviser or mortgage adviser. They will need to have the right qualifications to advise on and arrange equity release. An independent mortgage broker can compare products from the whole of the market. They will be able to find the product that best suits your needs at the lowest cost. At Bigmore Associates, we specialise in retirement planning and later life lending and can offer a no obligation consultation to see if equity release may be the right solution for you.
Is Equity Release regulated?
The Financial Conduct Authority (FCA) are responsible for the regulation of equity release products.
The Equity Release Council is the leading industry standards body for lifetime mortgages. Members must be qualified, so seeking out advisers who are members of the council will help to ensure you are dealing with somebody who is committed to the highest standards of advice. The Equity Release Council has a handy search function on their website for solicitors and financial advisers who are members. Bigmore Associates is a member of the Equity Release Council.
Lifetime mortgages provide many who would otherwise not be able to raise any money at all through a mortgage – either owing to income levels or age – with a unique opportunity to meet their capital raising requirements, be that for income, one off expenses or to gift money to family members. However, it’s important to bear in mind that their unique structure carries risks not applicable to other types of mortgage that mean they’re not suitable for everybody. When it comes to equity release, a healthy mantra to keep in mind would be don’t take money you don’t need, and don’t take it too early in life. Finally, whilst this is true for many types of mortgages, with a lifetime mortgage even more so than others, it’s vital to educate yourself and seek unbiased, professional advice.
Article by Cain Stennett
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