Releasing cash from your property is a popular choice for many over 55’s who own their own home and would like to increase their disposable income in later life, giving them more financial freedom to enjoy holidays, carry out home improvements, splash out on a new car or help out family members.
Traditionally, equity release mortgages were the only way to unlock the capital in your home.
However, increased interest in this type of mortgage has driven innovation in retirement lending in recent years and there is now more choice for later life borrowers.
The Financial Conduct Authority introduced ‘retirement interest only’ (RIO) mortgages in 2018 which are more flexible than equity release mortgages and generally have lower interest rates.
PIL is a leading mortgage broker in the Southampton area. In this article, we compare the features of both these products.
The main drawback of an equity release mortgage is that interest rates are generally higher than ordinary mortgages, as rates are fixed for the duration of the loan and, as there are no monthly payments, the interest is generally ‘rolled up’ during the loan, meaning that the borrower ends up paying compound interest – interest on interest.
Compound interest can increase a loan to an alarming degree. For example, if you borrow £20,000 at age 60, at 6% on a £250,000 home, the amount you owe will double every 12 years. By this calculation, if you live until 72 you’ll owe £40,000 and, if you live until 84, you’ll owe £80,000.
Some lifetime mortgages (the most common type of equity release mortgage) do allow repayment of interest each month which can help to reduce the build up of interest.
With a RIO, the interest rates are generally lower and, as you pay the interest off each month, there is no rolled up interest charge. The amount you borrow when you take out the RIO is what is repaid at the end.
With an equity release mortgage, there are no mandatory monthly payments as the interest is added to the loan, although you can choose to pay interest payments if you wish.
As we highlighted earlier, if you choose not to pay interest payments on your equity release mortgage, the compound interest will dramatically increase the loan amount your estate will have to repay.
With an RIO, you have to pay a monthly interest payment, which may or may not suit your financial circumstances.
If you decide to repay an equity release mortgage before you die, the fees can be a substantial part of the loan value, which can make it prohibitive to get out of.
With a RIO, you have the option to take one out for various term lengths, starting at two years, or you can take out a RIO to cover the rest of your life, it’s up to you. The benefit of this is that you can choose to repay it or to move house and downsize without incurring significant exit fees.
An equity release mortgage product is generally a more complex option than a RIO mortgage.
As RIOs are set up to ensure that interest is paid on the loan, you are assured that the equity going into your estate will be preserved.
However, with an equity release mortgage, the interest that compounds through the life of the loan can significantly add to the debt, which will reduce the value of your estate.
RIOs have the added benefit of allowing you to overpay, which gives you the opportunity of reducing the debt you owe and leaving a larger estate to be inherited by your beneficiaries.
Note: In March 2022, The Equity Release Council introduced the fifth product standard, which is a product feature enabling borrowers to make a penalty-free partial loan repayment to mitigate the effects of compound interest.
A benefit of equity release products is that the cash is tax-free, so there is no income tax payable on the equity that has been released.
If you have a standard interest-only mortgage, and your home has enough equity in it to repay the capital sum at the end of your interest-only mortgage period, you could use an equity release mortgage product to pay off your standard mortgage.
People who are still repaying a capital repayment mortgage could pay it off with a RIO if they can keep up with the monthly interest payments. If you are looking at this option, you will need to include any redemption fee on your current mortgage in your calculations.
We have a team of helpful mortgage advisers who will listen to your needs and use their experience and knowledge to help to find the most suitable mortgage product for you. We have access to several Equity Release specialists from the wider group if this is the right option for you.
How you can contact PIL Southampton
Our expert mortgage advisers are here to guide you through the mortgage process, every step of the way. You can email us, fill out the contact form on our website or call us on 02380 668407. We look forward to hearing from you.