Taking out the equity in your home

Fast-rising home values have more homeowners sitting on newfound home equity. Home equity is the current value of a home minus the amount of mortgage debt against it.

Over the course of 2017, the amount of equity borrowers could take out of their homes, or so-called tappable home equity, rose by $735 billion, the largest annual increase by dollar value on record, according to Black Knight. This brought the collective amount nationwide to $5.4 trillion, which is 10 percent more than at the pre-recession peak in 2005.

Home equity represents valuable savings, but it can also be a valuable finance tool. Homeowners often tap it to pay for other expenses, like education, home repairs or remodeling – or to pay off other, more expensive debt.

So what is the best way to do it?

First, remember that most lenders require you to keep at least 20 percent equity in your home, just as a cushion in case home prices fall. If you don't have more than 20 percent equity, then you are unlikely to qualify.

If you do have at least 20 percent, the most common ways to tap the excess equity are through a cash-out refinance or a home equity loan.

For a cash-out refinance, you refinance your current mortgage and take out a bigger mortgage. For example, let's say your home is worth $100,000 and you have a $40,000 mortgage on it. Remember, you have to keep 20 percent in, so $20,000. That means you have $40,000 in equity to tap. You refinance your current mortgage to up to $80,000. Pay off the old loan and have $40,000 left in cash.

This is a good plan if interest rates are currently lower than the rate you have on your old mortgage. If not, a home equity loan might be a better option.

A home equity loan can be a second loan on your home. So you keep the first mortgage and take out another. You can do this in a lump sum or a home equity line of credit, which is like a checking account on your house. Lenders call these HELOCs for short. You only pay interest on what you take out. Home equity loans can be interest only, but after 10 years you have to start paying principal.

There will be fees for all of these options, and the more money you take out, the higher your monthly payment will be. Make sure you can swing it. A house can be a great finance tool, but it's also a great way to save equity for the future.

Equity release refers to a range of products letting you access the equity (cash) tied up in your home if you are older. You can take the money you release as a lump sum or, in several smaller amounts or as a combination of both.

Equity release options

There are two equity release options.

• Lifetime mortgage: you take out a mortgage secured on your property provided it’s your main residence, while retaining ownership. You might be able to ring-fence some of the value of your property as an inheritance for your family. You can choose to make repayments or let the interest roll-up. The loan amount and any built-up interest is paid back by selling the property when the last borrower dies or when they move into long-term care.
  
• Home reversion: you sell part or all of your home to a home reversion provider in return for a lump sum or regular payments. You have the right to continue living in the property until you die, but you have to agree to maintain and insure it. You can ring-fence a percentage of your property for later use, possibly for inheritance by only selling part of your property. The percentage you retain will always remain the same regardless of the change in property values, unless you decide to take further cash releases. When the last borrower dies or moves into long-term care your property is sold and the sale proceeds are shared according to the remaining proportions of ownership.

Lifetime mortgages

Most people who take out equity release use a lifetime mortgage.

Usually you don’t have to make any repayments while you’re alive. Instead, interest is ‘rolled up’, which means the unpaid interest is added to the loan. This means the debt can increase quite quickly over a period of time.

However, some lifetime mortgages do now offer you the option to pay all or some of the interest, and some let you pay off the interest and capital.

In the same way ordinary mortgages vary from lender to lender, so do lifetime mortgages.

Find out the answers to the following questions when you’re looking into getting a lifetime mortgage

• What is the minimum age you can take out a lifetime mortgage? Usually, it’s 55. We’re all living longer so the earlier you start the more it’s likely to cost in the long run especially if you choose not to pay interest during the term of the lifetime mortgage.
  
• What’s the maximum percentage you can borrow? You can borrow a percentage of the value of your property, but this depends on a number of factors such as your age and the value of your property. The percentage typically increases according to your age when you take out the lifetime mortgage, while some providers might offer larger sums to those with certain past or present medical conditions.
• Can the interest rate be fixed? Yes, but if they’re variable, there must be a “cap” (upper limit) which won't change for the life of the loan (Equity Release Council standard).
• Make sure the product has a “no negative equity guarantee”. This means when your property is sold, and agents’ and solicitors’ fees have been paid, even if the amount left is not enough to repay the outstanding loan to your provider, neither you nor your estate will be liable to pay any more (Equity Release Council standard).
• Ensure you have the right to move to another property subject to the new property being acceptable to your product provider as continuing security for your equity release loan (Equity Release Council standard). Different lifetime mortgage providers might have slightly different policies.
• Whether you can pay none, some or all of the interest. If you can make repayments, it will reduce the total amount of interest payable when the property is sold. With a lifetime mortgage where you can make monthly payments, the amount you can repay might be based on your income. Providers will have to check you can afford these regular payments.
• Whether you can withdraw the equity you’re releasing in small amounts as and when you need it or whether you have to take it as one lump sum. The advantage of being able to take money out in smaller amounts is you only pay the interest on the amount you’ve withdrawn. If you can take smaller lump sums, make sure you check if there’s a minimum amount.
  

Home reversion

Home reversion allows you to sell some or all of your home to a home reversion provider.

The provider effectively co-owns your home, unless you've sold the whole property, but you keep the right to live there for the rest of your life, potentially rent-free.

In return you’ll get a lump sum or regular payments.

You’ll normally get between 20% and 60% of the market value of your home (or of the part you sell).

When considering a home reversion plan, you should check:

• Whether or not you can release equity in several payments or in one lump sum.
• The minimum age at which you can take out a home reversion plan. Some home reversion providers insist you’re at least 60 or 65 before you can apply.
• The percentage of the market value you will receive. This will increase the older you are when you take out the plan but might vary from provider to provider.

What level of maintenance you’ll be expected to carry out and how often your property will be inspected (this could be every few years).

Things you need to know about equity release

Equity release might seem like a good option if you want some extra money and don’t want to move house.

But, there are some reasons why equity release might not be the best fit for you.

• Equity release can be more expensive in comparison to an ordinary mortgage. If you take out a lifetime mortgage you will normally be charged a higher rate of interest than you would on an ordinary mortgage and your debt can grow quickly if the interest is rolled up.
• For lifetime mortgages, there is usually no fixed “term” or date by which you’re expected to repay your loan. The rate of interest of a lifetime mortgage will not change during the life of your contract, unless it's a variable rate. The interest rate you pay on any drawdowns will be determined at the time of drawdown and not at the time the contract is entered into so this may be different to the previous rate. If you take any additional borrowing the interest rate you pay may be different and it will only be applicable to that cycle of extra borrowing.
• Home reversion plans will not give you the true market value of your home when compared to selling your property on the open market due to the fact you're allowed to live in the property for the rest of your life, which you could not do so if you sold the property on the open market.
• If you release equity from your home, you might not be able to rely on your property for money you might need later in your retirement. For instance, if you need to pay for long-term care.
• Although you can move home and take your lifetime mortgage with you, if you decide you want to downsize later on you might not have enough equity in your home to do this. This means you might need to repay some of your mortgage.
• The money you receive from equity release might affect your entitlement to state benefits.
• You will have to pay arrangement fees, which can reach approx. £1,500 - £3,000 in total, depending on the plan being arranged.
• If you’ve taken out an interest roll-up lifetime mortgage, there will be less for you to pass onto your family as an inheritance.
• These schemes can be complicated to unravel if you change your mind.
• There might be early repayment charges if you change your mind, which could be expensive, although they are not applicable if you die or move into long-term care.
• These schemes can impact the inheritance you pass down to family members. It's important to discuss your plans with your family in order to avoid potential conflicts and complications later on.
  

Is releasing equity the right option for you?

Whether equity release is the right option for you depends on your circumstances such as:

• your age
• your income
• how much money you want to release
• your plans for the future.

When releasing equity, it’s tempting to focus on the immediate boost you will get from the money you unlock, but you need to look at how it will affect your future choices and financial situation in later life.

Getting advice

If you’re thinking of taking out an equity release product, you should take financial advice from an independent financial adviser. They'll be able to suggest a plan suitable for your needs by researching all the products on the market. 

All advisers recommending equity release schemes must have a specialist qualification.

Check your adviser

• searches the whole of market, so they can find the right plan for you
• is on the Financial Conduct Authority register  (search by the firm’s name) – a firm on the FCA register is regulated and must sign up to the Financial Ombudsman Service, which is a free-to-use complaints service if you’re unhappy with the service you receive
• is a member of and on the Equity Release Council member directory so you can be sure they abide by the trade body’s strict Rules and Standards which go beyond the basic regulatory requirements.

Before you decide whether or not to take out an equity release product, ask the adviser:

• what their fees are
• what type of equity release products they can offer
• what other fees you’ll have to pay (eg. legal, valuation, set up costs).

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Looking for us? Now, we’re MoneyHelper

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