What is the cost of setting up an equity release plan?

Under the terms of your Lifetime Mortgage, the rate of interest that will be charged on your loan will either be fixed, or it will be variable, in which case there will be a “cap” (upper limit) on the amount that can be charged at any time.  If the rate is fixed, it will be fixed each time you withdraw funds from your plan.  Over time, therefore, you could have several amounts of money which you have released at different times, and each would be subject to a different fixed rate of interest, which would then be added to the total amount which you have borrowed. You will not have to pay back any of this money until your plan comes to an end and your property is sold or you choose to repay the loan.  At the time you take out the plan you may however be asked to pay a number of other fees to cover the costs of setting up the plan.  They will include fees payable to:

  • The Provider which is financing your plan.  These may be described as “application” or “administration” fees;
  • Your Adviser, who will carry out detailed research into the options and recommend the most suitable plan from the range available, followed with a written report containing recommendations and a personalised Key Facts Illustration (KFI). Should you wish to proceed, your adviser will arrange all of the required paperwork with the provider and handle things through to eventual completion and release of the funds;
  • Your Solicitor, for giving you independent advice on the plan to help you understand how it will work, and for carrying out the necessary conveyancing (legal) work; and
  • The surveyor (valuer) who will inspect your property in order to give the provider an independent estimate of its value at the time you take out the plan.

Some firms may not charge fees in all of these categories and others may structure their plans so that they offer cash-backs in order to balance the cost for you.  You will need to research the market thoroughly to ensure that you find an option which suits you.  The level of fees may also vary between firms, clients will always incur own solicitor costs, but some adviser firms don’t charge any fee and neither do some providers. Typically, however, you can expect to pay approximately £2,000 – 3,000 in total depending on the amount released and the plan being arranged.

How might house prices increase during the life of my equity release plan?

It’s difficult to predict how house prices rise and fall – and although there are frequent reports in the press about national figures, there may be big variations according to where you live.  Set out below is an example based on a cautious house price growth figure of 4% and an interest rate of 6.39% on the equity release loan. The example is based on a plan where all the equity is released together and interest begins to grow from day 1.

Year of loan

House price

Loan size

Equity left (£)

Equity left (%)

Start

£250,000

£65,000

£185,000

74%

After 5 years

£292,464

£83,273

£209,191

71%

After 10 years

£355,825

£113,501

£242,324

68%

 

So at the beginning of the plan, the customer would have owned just under three-quarters of the value of the property (74%).  After 5 years s/he would own a bit less than that (71%) and after 10 years s/he would own just over two-thirds of the value of the property (68%).  If the customer were to die after 10 years and the house were sold, s/he would be able to leave approximately £242,324 as an inheritance.  That is of course less than the house was worth when the plan was originally taken out – but the customer will have had the benefit of the £65,000 loan in the meantime – interest-free.  

Why are the interest rates on equity release loans higher than on standard mortgages?

In recent years, interest rates have been at historically low levels. However, people sometimes ask why interest rates on equity release products appear to be higher than standard mortgages.  Equity release loans and reversions are different from the mortgages which people take out to buy their homes - and different factors need to be taken into account when the providers work out how much they need to charge.

With a standard mortgage, you are making regular payments to the lender – typically every month. A standard mortgage is always for a fixed period of time which is quite different from LTMs. With an “interest-only” mortgage you are only repaying interest on the loan which you took out – and at some point you will have to repay the lender the full amount of the capital (the original loan) borrowed.  With a “repayment” or “capital repayment” mortgage, you are repaying a small amount of the actual loan (capital) each time, combined with interest on the whole loan.  Your aim is – eventually – to repay all the money which you borrowed by the end of the period of your mortgage (e.g. 10years), so that you end up owning your property outright.

Equity release is designed to help older customers who either already own their property outright, or have relatively small mortgages left to pay. They may decide to “release equity” in their property - that is, take out a loan or sell part of the value of the property – knowing that they will not actually pay that money back to the lender (or reversion provider, in the case of a home reversion plan). The loan or reversion sum will be repaid at a future date, when the property is sold. That means that the provider’s money is potentially tied up for an unknown number of years, during which time the provider will not be receiving any payments from you (unlike with a standard mortgage, where the provider will be receiving regular monthly payments). Additionally, the protections that are in place to manage the contract – i.e. security of tenure, and no negative equity guarantee cost the provider firm (lender) significant funds to set up and maintain. So the cost to the provider of making the equity loan, or buying part of the equity in your property, is more expensive than it is for a standard mortgage lender – and that’s why the interest rate is also higher. 

What does rolled up/compound interest mean?

If the plan that you take out is one where the whole amount of the interest is “rolled up”, that means that at the end of the first year, the amount of interest charged will be added to the amount you have borrowed.  The next year, the interest will be “compounded” – that means, it will be calculated on the sum of your original loan plus the interest which was charged during the first year.  The same process will be done the next year and the next - so although the interest rate that you are being charged will remain the same each year, it will be calculated on a larger amount each time, because the total amount that you owe will grow with each year.  

Lets take a simple example. The interest on an equity release loan is rolled up every year, that is, the amount of interest charged is added to the amount of the loan, and the interest for the following year is worked out on the sum of the original loan plus the interest which was charged during that year. So although the interest rate will remain the same each year, it will be calculated on a larger amount each time. 

Let’s take a simple example, where the original loan is for £50,000 and the interest rate is 6%:

Year

Loan

Interest at 6%

Total owed

1

£50,000

£3,000

£53,000

2

£53,000

£3,180

£56,180

3

£56,180

£3,370

£59,550

4

£59,550

£3,573

£63,123

5

£63,123

£3,787

£66,910

 

While it may look as if the total owed is growing rather fast, it is quite likely that the value of the property will also be growing – so you will still own “equity” in the property.  Your share of the equity may not be the same as when you took your equity release loan out – however it will not be significantly lower.  (See question: “How might house prices increase during the life of my equity release plan”  for an illustration of how your share of the equity in your property might be affected by house price increases).

Before you apply for an equity release plan you will be given a “key facts illustration” which sets out the main details about the plan.  Section 8 of the illustration will set out more fully how your particular loan and interest will build up over the years.

When considering an equity release plan we recommend customers talk to a specialist member of the Equity Release Council. All of our members have agreed to abide by the Council rules and have signed up to the Statement of Principles.

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