Releasing equity from your home could be a useful financial solution in retirement, but only if you avoid the top equity release pitfalls! 

The second quarter of 2024 saw £578 million taken out through equity release plans by UK homeowners.¹ 

Could you benefit from one of these popular products? If yes, are you aware of the potential risks?

Discover the top 10 equity release pitfalls so you know how to avoid them when accessing the money tied up in your home.

What Is Equity Release?

‘Equity release’ refers to a type of retirement product that allows homeowners over 55 to access some of their home’s value as a cash loan without having to sell the property.

Equity release plans differ from traditional mortgages by not requiring monthly interest repayments.

Instead, the loan and interest are usually repaid when the homeowner passes away or moves into long-term care.

An equity release plan can be used to unlock cash tied up in property to fund retirement, home improvements, early inheritance, or many other needs.

Though equity release comes with a number of advantages, you will have to keep in mind the potential risks and downsides.

What Are the 10 Biggest Pitfalls of Equity Release?

The 10 biggest pitfalls of equity release include not understanding the effects of compound interest, releasing more money than you need, and not being able to use your home as security for other loans. 

Here are the top 10 equity release pitfalls:

1. Effect of compound interest
2. Borrowing too much
3. Effect on your benefits
4. Early exit fees
5. Reduced or no inheritance
6. Setup fees
7. No more loans with your house as security
8. Lower market value of your home
9. Borrowing when you’re younger
10. The “setup & forget” catch

Let’s unpack each of these pitfalls, so you know exactly how to avoid them.  

#1. Effect of Compound Interest

A lifetime mortgage is the most popular type of equity release product.²

A lifetime mortgage allows homeowners to access their home equity as one large sum or in smaller instalments (known as drawdown) when needed.

Compound interest is one of this type of loan’s biggest pitfalls. 

How does it work?

Providers lend homeowners money at a fixed interest rate, and interest then accrues and compounds throughout the life of the loan. 

Compound interest is usually described as ‘interest charged on interest’. 

This means that when taking out a lifetime mortgage, you’ll be charged interest on both your principal loan and any accrued interest.

So, although your interest rate stays the same for your loan term, the actual interest amount grows with every payment. 

Is there a solution?

One way of mitigating the effect of compound interest is to make voluntary repayments on your loan. 

Thanks to a new safeguard³ introduced by the Equity Release Council (ERC)⁴ in January 2022, what used to be a chargeable feature is now standard practice. 

Providers who are members of the ERC must now allow customers to make voluntary partial repayments without an ongoing commitment. 

Making voluntary repayments is a great way to keep the interest costs down on your loan.⁵ 

#2. Borrowing More Money Than You Need

Borrowing more money than you need can be a natural reaction to knowing how much money you have at your disposal.

Since equity release interest accrues and compounds over time, releasing equity when you do not need it will lead to an unnecessary expense.

Is there a solution?

One way to prevent this is to apply for a drawdown equity release plan instead of a lump sum plan.

A  drawdown plan allows the release of a smaller initial lump sum while the remaining equity remains in a cash reserve. 

You’ll be able to access money from the reserve as and when needed, subject to minimum amounts set by your provider. 

The main benefit of a drawdown plan is that you only pay interest on the money you release and not on the funds that remain in your reserve. 

Tip

While it’s great to know you have a certain amount of money at your disposal, try to plan ahead and budget according to your financial goals. 

#3. It Affects Your Benefits

Means-tested benefits may be affected by releasing equity. 

Whether you’re eligible for state benefits depends on a combination of your capital, income, and savings.

Releasing equity will likely result in your exceeding the government saving limits⁵, which in turn, could discount you from being able to receive state benefits.

Similarly, if you release equity to pay off any outstanding mortgage, your regular mortgage payments will no longer be required. 

If you no longer have housing costs, certain means-tested benefits, such as Universal Credit, may be reduced or stopped altogether.

This is because your eligibility for these benefits is partly based on how much capital you own, and the more equity you have in your home, the more capital you have.⁶

Your broker or financial advisor can help determine the effects of equity release if you receive state benefits. 

With their help, you’ll be able to weigh up your options and find the best solution to meet your financial goals. 

#4. Early Repayment Fees

Providers may charge an early repayment fee (ERC) if you wish to repay the loan before it’s run its entire course or if you exceed the agreed repayment limit.   

ERCs exist as a means for providers to cover the losses they could incur when an equity release loan is repaid sooner than anticipated. 

There are 2 different types of early repayment fees: 

• Fixed ERCs
• Variable ERCs 

It’s extremely important to understand which type your provider charges and how it works.

Fixed ERCs:

• Fixed ERCs involve a fixed fee that usually tapers over time. 
• For example, the penalty fees could be 10% of your loan if you cancel in the 1^st year, 8% in the 2^nd and 6% in the 3^rd, until eventually, the penalty fees fall away.⁷

These figures are purely indicative and will entirely depend on your provider’s terms and conditions. 

Variable ERCs:

• Unlike fixed ERCs, variable ERCs fluctuate based on the value of government bonds known as gilts.⁸
• ERCs aren’t due if gilt yields rise between the date of releasing equity and the borrower’s early repayment effort. 
• However, if gilt yields fall between those 2 events, the provider will charge an ERC based on the value decline.⁹

Your provider must advise you of these fees before you commit to the agreement. 

#5. Reduced or No Inheritance

Taking out an equity release plan will reduce the inheritance you leave, as you’re essentially spending a portion of your home value. 

Is there a solution?

You could take out an inheritance protection guarantee with your equity release loan. 

This feature allows you to set aside a percentage of your home’s value to be passed down to your heirs upon the sale of your home.¹⁰

Another way to reduce your estate’s eventual debt and thus increase the inheritance available to your heirs is to pay off a portion of the interest on your equity release loan.

Even though equity release can reduce the value of your estate, your broker or financial advisor can help you find ways to manage it effectively.

#6. Setup Fees

Make sure you ask your financial advisor or broker about all the fees for releasing equity from your home. 

Although you won’t have to pay back any part of your capital loan or the interest accrued unless you choose to do so, there are other fees you’ll have to pay.¹¹

These fees could include the following: 

• Application or administration fees
• Advice fees
• Solicitor fees
• Valuation fees

You should be prepared for all these fees, which can add up to anywhere from £1,500 to £3,000.¹²

#7. Difficulty Getting Further Loans

Equity release may prevent you from taking out other loans against your property in the future.

Having more than two secured loans against your home is possible¹³, but it stands to reason that releasing all of the equity will prevent you from using it as security for future loans.

If you only release some of your equity, you could release the remainder through a second equity release plan or a personal loan further down the line. 

Your provider’s terms and conditions will dictate whether this option is available to you.

#8. Losing Out on the Market Value of Your Home

Equity release in the form of a home reversion plan enables a provider to buy all or part of your home at less than its market value.¹⁴ 

The provider’s ownership percentage remains the same throughout the loan period, so when the house is sold at its expected market value, that percentage is paid as a settlement. 

#9. Borrowing When You’re Younger

When you release equity from your home at a younger age, the interest will accrue over a longer period.

If you choose not to make any interest repayments during the life of your loan, you or your estate could end up paying back more in interest than your initial loan. 

Your age will also affect the amount you can borrow and the fixed interest rate you can secure.  

Your financial advisor or broker can look at the best plan based on your age, property value and desired outcome. 

In short

It might be worth waiting until further into retirement before turning to equity release for extra funds. 

#10. The “Setup & Forget” Catch

It can be easy to take out equity release and forget about it. 

However, this might not be a good thing. 

With the equity release market constantly changing and becoming more competitive, new products, features and safeguards are being introduced. 

Ideally, homeowners should review their equity release plans every few years. 

Not only will this allow your financial advisor or broker to suggest better-suited plans, but you might find that the older you are, the more equity you can release. 

The big question

With all that said, is equity release still a good idea? 

It certainly could be if you avoid the pitfalls.

How to Avoid Equity Release Pitfalls

The equity release pitfalls above might sound daunting, but the good news is that you can avoid them. 

Here are some steps to avoiding the most common equity release pitfalls: 

• Seek advice from a leading financial advisor or broker with experience across the entire equity release market. 
• Look at your alternatives to determine if equity release is the right option for you. 
• Be sure to consider providers that are members of the Equity Release Council. 
• Make sure any provider you consider offers features such as a No Negative Equity guarantee and the option of making partial repayments. 
• Carefully consider the effects equity release could have on your benefits. 
• Only release the amount that you need.

Financial Literacy and Education Initiatives

Equity release institutions support financial literacy and education programs aimed at empowering individuals to make informed financial decisions.

For example, the Certificate in Regulated Equity Release (CeRER) is a professional qualification that equips advisers with the knowledge and skills to provide equity release advice.¹⁵

Additionally, the financial services industry, including equity release institutions, has been actively involved in financial education initiatives, reaching millions of individuals and providing essential financial skills.¹⁶

By investing in these initiatives, these institutions help people build a more secure financial future, leveraging the power of equity release for community empowerment.

Common Questions

In Conclusion

Equity release can be a good option for homeowners who need a quick cash injection or want a more comfortable retirement. 

Although there are many equity release pitfalls, getting professional advice from the right financial advisor or broker will put you in the best position to find the plan most suited to your circumstances.