In this brief blog, we are going to talk about the pitfalls of equity release and what we can do to mitigate the pitfalls of equity release.

Equity release schemes have been very popular in the UK with over forty thousand households where the owners are over fifty-five years of age now releasing the equity in their homes and providing themselves with extra income in order to live out the rest of their retirement.

To be eligible for an equity release product in the UK, you will usually need to have paid off at least 60% or all of your mortgage and be at least 55 years of age.

Releasing equity in your home can allow you to gift your family members mortgage deposit, invest in more properties, buy a new car, renovate your home and even go on a holiday. There is no restriction on what you can do with money released from the equity in your home.

There are some pitfalls of equity release and will discuss them below

Pitfalls of equity release

Some of the pitfalls of equity release which you should watch out for include:

Rolled up interest

Reduced inheritance

Limits to how much you can release

Early repayment charges

Miss out on the increase in property value

You may have high fees

You may miss out on your benefits

 Pitfalls of equity release

Rolled up interest

Rolled up interest is one of the biggest pitfalls of equity release. As most equity release products do not require the borrower to make any monthly repayments towards the interest being charged on their equity release product. This means that the interest being charged on the equity release product is being added to the outstanding balance and further interest is being charged on the combination of balance plus interest accrued. 

This means that interest is being charged on a balance that continually rises and compounds on itself. This is known as compounding and the interest is known as compound interest.

Compound interest rises faster than normal and can cause the borrower to end up owing more than they may have previously thought and in some cases owing more on the equity release than their properties are worth or up to what their properties are worth.

Most equity lenders in the UK are part of the equity release council which has a strict guideline that all members offer a no negative equity guarantee.

While this is is good and essentially eradicates the possibility that when you die your family will have to pay towards your equity release product as you owe more than your home was worth and the sale of your home still left an outstanding balance on the equity release.

This also means that you may potentially end up owing as much as your property is valued and leave nothing to your children as an inheritance.

You Can manage the amount of interest you are being charged on your equity release product by taking a drawdown equity release product which allows you to draw down funds as and when you need it. This means you will only be charged interest on the balance you are utilizing rather than the total balance you have been approved for.

 Pitfalls of equity release

Reduced inheritance

A  reduced inheritance is also a major pitfall of equity release products. Due to the fact that many equity release products do not require borrowers to make a monthly repayment which goes towards the interest being charged on their equity release products.

As the interest compounds, it reduces the amount of equity you have in your property as you will use the remaining equity in your property to repay the equity release product in full when your property is sold. 

Example: You have a £100.000 property and took out a £30,000 equity release product which would have been repaid by your £100,000 property being sold and £70,000 being returned to your family as theirs to keep.

With an equity release product, the interest charges will usually compound and increase the balance you owe from £30,000 to more like £50,000. This means that upon the sale of your £100,000 property you will only receive £50,000 which your family may inherit rather than the £70,000 they may have inherited.

Some equity release providers allow you to ring-fence some of the equity in your property so that your family will have an inheritance.

Limits to how much you can release

Another pitfall of equity release products is the limit to which you can release. Equity release providers will usually increase the amount you can release based on how old you are and how likely you are to die. This means the younger you are the smaller you will be able to release through equity release products.

You may find that there are more suitable financial products out there which you can utilize than using an equity release product.

Early repayment charges

High early repayment charges can also be a major pitfall of equity release products. Most equity release providers will place high early repayment charges on their equity release products which make it almost impossible for you to switch equity release providers to a better rate or for you to move homes (although most equity release providers may allow you to port your equity release product).

The early repayment charges on equity release products are so much higher because the equity release providers do not intend for you to repay your equity release during your lifetime and try and dissuade you from doing so.

That said, however, most of the new equity release plans come with fixed-term advance arrangement fees, which means that with a few years in, you can change and decide to close it.

Miss out on an increase in property value

Another major pitfall of equity release products is that you will miss out on any increase in your property value as most of the equity in your property will no longer belong to you.

Some equity release plans such as the home reversion plan require you to sell some or all of the equity in your home to a provider in return for a large upfront sum and the ability to live in your home rent-free.

This means if property prices rose you won’t be able to benefit from the rise in property prices as you won’t have any equity in your property.

If you only sold some of the equity in your property then you will benefit from the rise in value on the equity you own but not the full value of the property.

You may have high fees

Most equity release providers will have high fees associated with getting an equity release product. The could be the high fees associated with getting equity release advice or the high equity release application fees.

When Considering all the fees involved it may be better to get a better suited financial product. Some of the fees included in an equity release product could be the valuation fee, the solicitor’s fee (as you need a solicitor to explain the agreement you are signing on to),: financial advice fee, and lenders fee.

The fees you may pay will differ from one equity release provider to another but the high fees involved with equity release products are one of the pitfalls of equity release.

You may miss out on your benefits

The income you may receive from your benefits may end up disqualifying you from any means-tested benefits which you were receiving.

Regardless of how you intend to go forward, you should always seek independent financial advice before taking out an equity release product as the pitfalls of equity release products can affect you and your beneficiaries.

In this brief guide, we discussed the pitfalls of equity release. If you think we missed anything then let us know in the comments.

John Bate

John has 22 years of experience in financial services. This spans across financial research, financial services (As a qualified mortgage broker and underwriter), financial trading and sales at global investment banks. While working as a publishing research analyst, he covered European bank credit and advised institutional clients on investment strategies at both JP Morgan and Societe Generale. John has passed all three levels of the CFA (Chartered Financial Analyst) programme.