How does equity release work?
What does interest roll up mean?
With a mainstream mortgage customers pay the interest due on a monthly basis. With a lifetime mortgage, the interest due is simply added to the mortgage account. This means that interest accrues over the term of the mortgage and can significantly impact on the amount owed over time.
Many lifetime mortgages now have a facility to allow payments to be made, which can alleviate this impact. This facility has been written into the Council’s Product Standards, so it must be included in all new products coming to market that providers wish to be Equity Release Council compliant.
What are fixed and gilt linked early repayment charges?
Most lifetime mortgage borrowers will never have to pay an early repayment charge (ERC). However, ERCs might be imposed by provider if a borrower wants to make repayments above the agreed limits or before a lifetime mortgage has run its full course. ERCs are there to cover the losses the provider may incur when a borrower repays sooner than was expected and there are two different types.
The first type, fixed (or defined) amount ERCs, are fixed but they can taper. For example, a provider might charge a penalty of 10% in year one, 9% in year two, 8% in year three and so on. Each provider has its own variation of this sliding scale, but borrowers will always know the fixed penalty up front.
The second type, variable ERCs, can seem complicated, but they are quite straightforward and are based on the value of something called a gilt. Gilts are government bonds often favoured by investors making long term investments, such as equity release providers.
If gilt yields rise in the time between the borrower taking out equity release and when they try to repay early, no ERC will be due. But if they have fallen, the provider will impose an ERC relative to the fall in value.
Gilt linked ERCs typically are capped at 25% of the amount borrowed and there are some instances when neither a fixed nor gilt-linked ERC will apply, such a compassionate window.
The Equity Release Council has produced two consumer factsheets which are available at the following links early repayment charges explained and calculating early repayment charges. Borrowers should always seek guidance from an adviser.
What happens if I want to repay the loan early?
If you repay a Lifetime Mortgage early you may have to pay an Early Repayment Charge. These charges can be quite expensive – but before you took your plan out you will have been given information about the maximum you might have to pay in the event that you decided to repay some or your entire loan early.
Most equity release plans are intended to be long-term options. You should make sure that you tell your adviser when you take out your plan if you think there might be circumstances in which you might want to repay your loan early. The products available vary – some have no early repayment charges, some apply the charge to a specific number of years after the plan was taken out, and others apply the charge throughout the life of the plan. You will need to take into account the cost of the plan you are considering along with the possible cost of an Early Repayment Charge – your adviser will help you decide which option is best for you, given your circumstances.
If you have a Home Reversion Plan and want to pay off the loan early, you may have to sell your share of the property to pay off the outstanding amount which you owe your provider. You may find that this leaves you with too little money to buy another property. However, the Equity Release Council’s rules require members to allow customers to move to a suitable alternative property, so if you are able to find another suitable and affordable property, this might be the best option for you.