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

UK homeowners took out a record 13,500 equity release plans between July and September 2022¹. 

Discover the top 10 equity release pitfalls to avoid them and access the money tied up in your home.

What’s Equity Release?

Equity release allows older homeowners over 55 to access some of their home’s value as a cash loan. 

You can choose one of 2 schemes, either a lifetime mortgage or a home reversion plan. 

With both schemes, you can receive cash in one lump sum or in smaller instalments.

Now that you know what equity release is, let’s look at the pitfalls you could potentially face.

What Are the 10 Biggest Pitfalls of Equity Release?

The 10 biggest pitfalls of equity release include 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. Compound interest
2. Taking more money than you need
3. Affects your benefits
4. Early exit fees
5. Reduced or no inheritance
6. Setup fees
7. No more loans with your house as security
8. Less 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. Compound Interest

A lifetime mortgage is the most popular equity release product², and compound interest is one of its biggest pitfalls. 

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

Providers lend homeowners money at a fixed interest rate that compounds throughout the life of the loan. 

Compound interest’s usually described as interest charged on interest. 

As a result, 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. 

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 loan⁵. 

#2. Taking More Money Than You Need

Taking 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 is an unnecessary expense.

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. 

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 you 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. 

Unless you spend that money in other ways, the government will count it towards your savings, which may push you over the limits mentioned above. 

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 (ERCs) 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 amount ERCs
• Variable ERCs 

Fixed-amount 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 1st year, 8% in the 2nd and 6% in the 3rd, until eventually, the penalty fees fall away⁶. 

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

However, your provider must advise you of these fees before you commit to the agreement. 

Unlike fixed ERCs, variable ERCs fluctuate based on the value of government bonds known as gilts⁷. 

ERCs aren’t due if gilt yields rise between 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 decline⁸.

#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. 

Despite this, there are ways to minimise the damages to your estate.  

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

It allows you to set aside a percentage of your home’s value to be passed down to your heirs upon the sale of your home⁹. 

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 that you’ll have to pay¹⁰. 

These fees could include the following: 

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

You should be prepared for all of these fees, which can add up to anywhere from £1,500 to £3,000¹¹.

#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 possible¹¹, 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. Less 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 value¹². 

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 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. 

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. 

With all that’s been 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.

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 best-suited plan for your circumstances.