Equity Release Mortgages

An equity release mortgage (sometimes referred to as a cash release scheme) is a specialised mortgage available to those who have paid off the mortgage on their property, or have very little left to repay. Equity is the term used for the difference between your property's market value and the amount you owe on your mortgage. This means that the equity should increase as you pay off a repayment mortgage because you owe your lender less and less and own an increasingly larger proportion of the property outright. Essentially, 'releasing the equity' allows you to convert the equity (which is effectively cash 'locked up' in your property) into a cash sum, or a regular income. These financial schemes are frequently offered to older home-owners who wish to increase their income using the value of their property, without moving out of their home. However, because these schemes are very complicated, you should always seek professional independent financial advice before you enter into any agreement.

Regardless of the type of equity release scheme you commit to, it is likely to affect your entitlement to state benefits and is usually more expensive than other money-raising options, such as 'downsizing'. Downsizing is the name given to the process of selling your existing home and buying one of a smaller value,and usually size, to help reduce maintenance costs.

Types of Equity Release Schemes
There are two main types of equity release schemes: lifetime mortgages and home reversions:

Lifetime Mortgage

A lifetime mortgage provides you with a secured loan that uses your home as collateral. However, unlike a standard secured personal loan, you are not required to pay monthly repayments, because the amount borrowed is repaid by the sale of your house after you die or if you move out of it: into a nursing home for example. A lifetime mortgage gives you the opportunity to remain the owner your home, because rather than selling it you are securing a loan against it.

There are a number of different types of lifetime mortgage: roll-up mortgage, fixed repayment mortgage, interest-only mortgage, home income plan and shared appreciation mortgage.

• Roll-Up Mortgage - interest is added onto the loan amount, either monthly or annually. You do not pay interest charges until your home is sold, whether after your death, or when you move out. Because the interest is added to the loan amount, you are subsequently charged interest on the interest: this is known as compound interest. As a result, the amount borrowed increases very quickly. This means that when your mortgage is paid off, the amount you owe is much larger than the amount you borrowed. For detailed information on how compound interest affects your debt see Compound Interest.

• Fixed Repayment Mortgage - your mortgage is repaid when your house is sold, whether after your death, or when you move out. You do not pay interest on this type of mortgage because you agree on a set sum with the lender which they can claim when your house is sold. This amount will always be larger than the amount you borrow and is mainly dependent on your age and life expectancy: the longer you live, the longer the lender has to wait to recover their money.

• Interest-Only Equity Release - works in a very similar way to a regular interest-only mortgage: you only pay the interest charges on the loan, rather than repay the amount borrowed. Unlike a standard interest-only mortgage, the amount borrowed is repaid when your property is sold, rather than through a savings or investment scheme.

• Share Appreciation - your lender is entitled to a share of the increase in the value of your property when it is sold. In return, they lend you money on which interest is not charged.

• Home Income Plan - uses the cash sum to buy an annuity, which is a form of investment that returns a regular income. A portion of this income is used to pay the interest charges on the loan and the remainder provides you with a supplementary income. The older you are when the annuity is bought, the larger this supplementary income should be. This is because you will not usually require as many payments as somebody younger.

Home Reversion

Conversely, a home reversion, which is the second main type of equity release scheme, involves you agreeing to sell all, or part, of your property to the reversion company. Under this scheme, you are entitled to continue to live in your home until you die, or choose to move out, which means that the reversion company is not able to re-sell your property to a third party. As a result, the cash sum you receive will not equal your property's full market value: you are usually offered between 25% and 60% of its value depending on your age. Some home reversion providers will offer to invest the money for you: consider seeking financial advice before deciding which option is best for you.

When your house is sold, the reversion company receives the agreed proportion of your property that you agreed to sell to them, which is likely to be a larger amount than you were lent. For example, if your property is currently worth £150,000 and you agree to sell sixty percent of your property, the lender would provide you with a cash sum of £90,000 minus a percentage amount based on your age. For example, if they give you just fifty percent of the value, your cash sum would be £45,000. When your house is sold, its value may have increased to £250,000. Because the lender has a sixty percent share, they are entitled to £150,000. The remaining forty percent would be given to you, or if you had died, pass into your estate, or be left to your family.

The Importance of Independent Financial Advice

Since equity release can be extremely complicated it is very important to seek independent financial advice before entering into any agreement. Financial advisers can help you to weigh up the advantages and disadvantages of equity release as well as answer any questions you may have, perhaps regarding the fees and costs you would incur, or the ease of cancelling an agreement once the contract has been signed. Equity release is often considered to be a last resort. Alternatives for raising money include: downsizing (selling your existing house and buying a smaller property); seeking additional state benefits; and using existing savings and investments. If you are struggling with your finances there are several sources of advice, such as the Citizens Advice Bureau and the Financial Services Authority's 'Money Made Clear' website.