Equity release: pros, cons and alternatives

Equity release lets homeowners over a certain age, usually 55 or older, take money out of their property without moving. The main form is a lifetime mortgage, where you borrow against the home and the interest usually rolls up and compounds until you die or move into long-term care. There is no monthly payment requirement unless you choose to make one. It is regulated by the FCA and advisers must hold a specific equity release qualification. The cost of compounding is the thing most people underestimate.

A lifetime mortgage is a loan secured on your home. You keep ownership. Interest is charged on the balance and, unless you pay it, it is added to the loan and itself starts earning interest. The debt is repaid from the sale of the property when the last borrower dies or moves permanently into care. You can take a lump sum, or use a drawdown facility where an agreed reserve is available to take in stages, with interest only accruing on what you have actually drawn. Drawdown is usually cheaper for that reason.

Home reversion is different and far less common. You sell all or part of your home to a provider in exchange for a cash sum or income, and you keep the right to live there rent free for life. You do not get market value. Providers pay well below it, because they do not get their money back until you die. The advantage is certainty about what proportion of the property your estate keeps. The disadvantage is that you have given up part of the ownership at a heavy discount.

This is where the numbers matter, so here is a worked example using an explicitly illustrative rate. Assume a 6 per cent annual interest rate that rolls up and is not serviced. This is an assumption for illustration only and not a quote or a market rate.

You are 68, your home is worth 400,000 pounds, and you release 80,000 pounds as a lump sum lifetime mortgage.

• After 5 years the balance is roughly 107,000 pounds.
• After 10 years it is roughly 143,000 pounds.
• After 15 years it is roughly 192,000 pounds.
• After 20 years it is roughly 257,000 pounds.
• After 25 years it is roughly 343,000 pounds.

At around 12 years the debt has doubled. At around 24 years it has quadrupled. If the property has also grown in value, the picture is less stark, but the debt is compounding at a fixed rate while property growth is uncertain. If the house is worth 600,000 pounds after 20 years and the debt is 257,000 pounds, your estate keeps roughly 343,000 pounds instead of 600,000 pounds.

The single most effective way to control this is to service some or all of the interest. Many modern lifetime mortgages allow voluntary payments, and paying the interest each month stops the roll-up entirely. If you can afford 400 pounds a month, the balance stays broadly flat rather than doubling.

The Equity Release Council is the industry body. Plans meeting its standards carry protections that materially reduce the risk of the product.

• A no-negative-equity guarantee, so your estate never owes more than the property sells for, however far the debt has compounded.
• The right to remain in your property for life, or until you move into long-term care.
• The right to make penalty-free partial repayments, on plans that meet the Council's standards, which is what makes interest servicing practical.
• A requirement that you receive independent legal advice from a solicitor of your own choosing.

Not every plan on the market is a Council member plan. Ask directly. Advisers giving equity release advice must hold a specific qualification beyond the standard mortgage adviser one, and the sector is FCA regulated.

Releasing equity converts an asset that is generally ignored for means-tested benefits, your home, into cash or savings that generally are not ignored. Pension Credit, Council Tax Reduction and Universal Credit are all means tested and can be reduced or lost if your savings rise above the relevant thresholds. Taking 60,000 pounds as a lump sum and leaving it in a savings account is one of the more common ways people accidentally lose entitlements. Drawdown plans help, because you only take what you need.

The state pension itself is not means tested and is unaffected. Attendance Allowance is not means tested either. But anything means tested must be checked before you proceed, not after. A good adviser will run this, and MoneyHelper offers free guidance.

The inheritance effect is simply the arithmetic above. The debt is repaid before anything passes to beneficiaries. Some plans offer an inheritance protection option that ring-fences a percentage of the property value, at the cost of releasing less. Whatever you do, tell your family. Adult children who discover a lifetime mortgage after a death, having assumed they were inheriting a mortgage-free house, are a well documented source of family conflict.

Downsizing is the obvious one and often the strongest financially. Moving from a 450,000 pound house to a 280,000 pound flat releases 170,000 pounds with no compounding debt at all, minus moving costs and stamp duty. The objections are usually emotional rather than financial, and they are legitimate objections. But run the numbers before dismissing it.

A Retirement Interest Only mortgage, or RIO, is a genuine middle path. You pay the interest monthly, so the balance never grows, and the loan is repaid when you die or move into care. Unlike a lifetime mortgage, a RIO requires you to prove you can afford the interest payments, which is a real hurdle for some. It generally has no fixed end date other than death or long-term care.

A standard mortgage or remortgage may still be available. Maximum ages have moved outward and some lenders will lend into the eighties where income supports it.

Check benefit entitlement. Pension Credit and Attendance Allowance go unclaimed by a large number of eligible households, and claiming them can remove the need to borrow.

Local authority home improvement grants or disabled facilities grants may cover the adaptation you were planning to fund.

Family help. A family loan documented properly, or a family member buying a share, can be far cheaper, though it needs legal advice on all sides.

Take drawdown rather than a lump sum unless you have a specific immediate need. Service the interest if you possibly can. Insist on a Council member plan. Involve your family in the conversation. Get the benefits check done first. And treat any adviser who does not raise downsizing and RIO with you as a warning sign.

If you want to compare equity release against a RIO or a standard later life mortgage, the MortgageMatch directory lists FCA-authorised firms, including advisers holding the specific equity release qualification.