Paying less inheritance tax, doing home improvements and paying off mortgages are key drivers behind the growth in people taking out equity release mortgages, despite rates still being high say financial planners.
The market for equity release, where you release tax-free cash from your home while you still live in it, has seen its first growth in a year in the third quarter of 2023, with new customers up by 10 per cent and total lending up 8 per cent, according to new figures from industry body the Equity Release Council. There were 7,379 new customers and 8,466 returning customers between July and September, borrowing a total of £716m.
This increase in equity release has happened as the rates of people paying the nation’s least favourite tax have continued to increase. The latest HMRC figures show that 17 per cent more people were paying inheritance tax last tax year compared with 2020 and 2021.
Equity release, which is most commonly in the form of lifetime mortgage, allows homeowners over the age of 55 to unlock money from their home. People commonly take out equity release to make financial gifts, improve their home and to pay off existing mortgages to reduce outgoings, says provider Legal & General.
By using equity release to pay off an existing mortgage, it means you aren’t committed to monthly payments as the interest can be paid off further down the line when you die or move into residential care.
When interest rates were at rock bottom, equity release became increasingly attractive as house prices soared in value. The average interest rate, which is fixed for the entire term of the loan, dropped to record lows of 3.86 per cent in 2021.
The rules of inheritance tax mean there’s normally no tax to pay if either the value of your estate is below a £325,000 threshold or you leave everything above the £325,000 threshold to your spouse, civil partner, a charity or a community amateur sports club.
If you give away your home to your children or grandchildren your threshold can increase to £500,000 as well.
Nick Onslow, a financial planner at Progeny Wealth, uses an example of a client who is single with no children, no pension and a house worth more than £325,000 as the type of person for whom equity release can still work for.
“Anything above £325,000 is subject to 40 per cent inheritance tax after death,” he said. “By taking a lump sum out of the estate and spending the money, the inheritance tax later paid by the beneficiaries will reduce.”
“Some use equity release as a way to give away money during their lifetime, and this gift may not be subject to inheritance tax if the giver lives another seven years. For every £1 you spend, your estate saves 40p,” adds Onslow.
Less than 1 in 20 deaths result in inheritance tax because of exemptions, so most people do not need to be concerned about it, but for those who may pass on an inheritance tax bill limiting it is of importance according to Mark Incledon, chief executive at Bowmore Financial Planning.
Incledon reports that this is becoming a more popular arrangement as a result of more people paying IHT because of rising property prices combined with the freezing of the tax thresholds, and that taking out a mortgage and gifting this money “can be an effective part of inheritance tax planning”.
For those who aren’t using equity release for tax planning, the high rates on this type of loans means the numbers may not add up. The interest rolls up and can snowball, leaving you or beneficiaries repaying far more than originally borrowed.
The average interest rate on an equity release loan is now at around 7 per cent, as the Bank of England has steadily increased the base interest rate over the past two years. Borrowing £50,000 with an interest rate of 7 per cent would mean around £100,000 is owed after 10 years and £203,000 would be owed after 20 years.
Many plans offer a guarantee that the total amount owed will never be above the value of your property. In January 2022, the average rate was just over 4 per cent.
One way to reduce the risk of snowballing debt is to make interest payments each month (and not to roll it up with the loan) – an option now offered by all new equity release plans.
“Repayments can be as little as £50 and can be made ad hoc or on a regular basis. I recommend all my clients make repayments to try and control the effects of compound interest,” says Andrew Morris, an equity release adviser at Age Partnership.
Julie Sedgwick, 72, from Weymouth, borrowed £55,000 through equity release this year after the death of her husband last December. Her three-bedroom house was valued at £380,000 and she wanted to release some of this money so she could boost her savings and help her two sons, without having to move.
She took out an Optional Payment Lifetime Mortgage through Legal & General, which means she pays interest monthly but can also stop paying at any time.
Overall, equity release can still be a good option for those who have limited savings but don’t want to move home to raise money. The high interest rates need careful consideration, along with other potential impacts if you claim state benefits.
It is recommended getting financial and legal advice to consider all the pros and cons, and to weigh up whether it’s suitable for your situation.
The Financial Conduct Authority (FCA), which regulates the sector, recently warned it had found many cases of advisers prioritising commission rather than a client’s best interests.
It has stated that lifetime mortgage advisers must consider the needs of consumers and communicate in a way which is clear, fair and not misleading.
