Equity release is a relatively new concept in the world of finance. When property prices began to soar over the last two decades, a situation arose where many people owned valuable properties, but due to rising costs of living did not have enough income to support their lifestyle during retirement. Equity release was an answer to this gap in the market.
Equity release mortgages allow you to free up some of the equity built up on your property, without the need to sell the house. It allows you to continue living in the house, but free up some of the value of the house and get it as a loan, either as a lump sum or in smaller regular installments.
The two main types of equity release mortgages are lifetime mortgages and home reversion plans. A lifetime mortgage is a loan taken against the home. Interest is generated on the loan, which usually compounds and results in a debt much bigger than the original loan. However, such loans do not need to be repaid until the homeowner dies or moves into permanent care, and the house is sold.
Modern equity release mortgages have a no negative equity policy. This means that if your debt becomes larger than the sale value of the house, the negative equity does not need to be repaid and is written off by the lender. This is how lifetime mortgages are repaid. In case of a joint application, the loan is expected to be repaid only after both the applicants have either died or gone into care.
Home reversion is a way to sell a portion of the house notionally, and take the loan of that amount. The loan and interest are repaid when the house is sold. The principal amount that needs to be repaid is the same proportion borrowed of the total sale value of the house. Therefore, the amount that needs to be repaid reflects the market value when the property is sold.
When interest builds up on the principal amount, this interest is added to the principal and the next year, interest is charged on this bigger amount. This compounding interest can result in huge debts, which is one of the main risks concerning equity release mortgages. Equity release lenders now offer what are known as interest only lifetime equity release mortgages wherein unlike roll up mortgages, you only pay the interest every month and when the equity release scheme ends, the amount to be returned remains the same as the amount borrowed.