Cleaned-up equity release: Handle with care

It's easy to see why so many people regard their home as their pension. As a country we have £3 trillion – that's a three followed by 12 noughts – tied up in housing.

With just over £1trn of that mortgaged, it's still an unimaginable sum of clear wealth. Enough, in fact, to bail out a couple of the most spendthrift eurozone countries. But how do you tap into this wealth safely and in the most cost-efficient way?

One option is to downsize – sell up, buy somewhere smaller and pocket the difference; happy days. But for many, the idea of selling the family home, with all those memories and friends nearby, just doesn't suit. It also costs a lot in stamp duty and other fees. For others, in this moribund market downsizing is a non-starter.

"Downsizing is not an option in large parts of the North and Northern Ireland as the property market is stuffed and there aren't the transactions," says Steve Laird, a director of Carrington Wealth Management.

So what next? One possible alternative is equity release. This has had some bad headlines over the years, with banks offering products in the 1980s and 1990s which proved to be a rank bad deal, leading to people effectively giving away their homes for relatively small amounts of money or ending in negative equity in their twilight years. The industry – now shorn of the big banks and down to key, specialist providers – has been cleaning up its act, offering a no-negative-equity guarantee and building a new generation of products which are more flexible and price-transparent.

But the spectre of mis-selling still lurks, ironically because of regulations meant to protect consumers.

Matthew Clark, a chartered financial planner at Thomas Westcott wealth management, and a specialist in retirement planning, says: "What is really worrying me is that the banning of commissions on the sale of investments, due to come into place at the end of the year, will lead to lots of less-scrupulous financial advisers moving in on equity release. As they are considered mortgage products they are not covered by this ban."

This worrying development could be happening at the same time as a surge in demand for equity release. For instance, a recent Independent on Sunday investigation showed upwards of 250,000 people will reach retirement still owing substantial sums on interest-only and endowment mortgages over the next decade.

"I would put people who take out equity release into three categories," Mr Clark says. "There are those who really need the money to pay off debts, those who are asset-rich but income modest and those who are actually quite wealthy and use it as a means of inheritance tax planning,"

Vanessa Owen, a director at LV=, one of the UK's biggest providers of equity release, says that common reasons for equity release relate to the upkeep of the household. "It's expenses such as roof or essential home repairs or paying for in-home care which often prompt people to take the plunge," she says.

A smaller minority take out equity release to support their children. "We see cases where parents use the lump sum for university fees or to help their child buy their first home.

"It's like unlocking an inheritance a little early," Ms Owen added.

Those looking at equity release have three options – a lifetime mortgage, a home income plan or a home reversion plan.

A lifetime mortgage is in effect a home loan where the interest builds up over the term and then is paid off, together with the capital sum, when the house is sold or the owners move into a care home. The key disadvantage is that it is a very open-ended agreement and interest rates can be high, relative to a standard mortgage.

However, lifetime mortgages can be flexible, offering a drawdown facility so borrowers can take their money in tranches when needed, and only pay interest from the moment they take each tranche.

Another innovation is the launch of products geared to people with medical conditions likely to shorten their life. Those who may live only a few more years due to, say, a heart condition, are allowed to draw more money because it's less likely the loan will run so long that it swallows up the value of the property.

"Because of such flexibility this type of equity release is proving more popular," Mr Clark says.

Home income plans, on the other hand, are declining in popularity.

"In effect, you exchange a proportion of your home for an income for life. The problem is that annuity rates are so low and these plans can be expensive and lack transparency. I don't recommend these," he says.

Home reversion plans are similar to home income, although there is the option to take a lump-sum payment instead, but Mr Clark urges caution.

"The difficulties emerge when you invest this lump sum. Who is to say that the performance will be good and the investment time period relatively short? In addition, if there are concerns about inheritance tax, then having money invested alongside the house doesn't really do much to help avoid it," he says.

In terms of age restrictions, some equity release schemes start from age 55, but more usually customers are in their mid-60s and upwards. The amount of money and income that can be gained depends on age, and the maximum proportion of a home that can be signed away to the equity release provider varies markedly. The older you are the more of your property you can unlock, but, as a rule of thumb, most loans are based on between 25 and 40 per cent of the property's current value.

In addition, with lifetime mortgages being more expensive, a standard home loan borrower can expect to see the amount they owe double in little more than a decade.

Carrington's Mr Laird says this makes it crucial to get the family on board. "It's not just a matter for the borrower, but for their potential beneficiaries," he says. "They should be consulted and independent financial and legal advice taken.

"Overall, though, for me, equity release should be a last resort. If you make proper, provision for your retirement through investments, savings and pensions you can avoid this expensive option in later life."