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Equity Release: Lifetime Mortgages

What are they - How they work

(sometimes called Interest Only Mortgages)

Page summary:

Equity Release covers different products including Interest Only Mortgages.

What are they and how can they help the older generation release built up equity in their homes while still being allowed to live in them.

Read more on this page.

What are Interest Only Mortgages - How do they work
Technically an interest only mortgage is not an Equity Release scheme because you don't have to be elderly to qualify. But they are another option for the older generation to consider when thinking about how to release built up equity in their property while continuing to live there.
Difference between an interest only mortgage and Equity Release

The main difference is that monthly repayments are incurred with an Interest only mortgage.

Whereas with a traditional Equity Release deal no repayments have to be made because the lender either takes a stake in your property and offers a lump sum in cash via a Home Reversion Scheme, or offers a lifetime mortgage which also pays a lump sum in cash with the interest being added to the original loan.

The loan and the accrued interest are then repaid when the house is sold, usually when the person dies or moves into long term care.

How an Interest Only Mortgage Works

A lump sum is borrowed which is secured against the value of your property. With a traditional style mortgage part of the monthly repayment goes towards paying off the loan principal and part to pay the interest.

But as its name suggests only the interest is paid with an interest only mortgage. But to qualify you therefore need to have a monthly income.

An example

  • Your property is worth £200,000
  • An interest only mortgage is taken out for £60,000 which you receive as a cash lump sum
  • The interest rate on the deal is fixed at 6.5%
  • The monthly repayments would be £325
  • On your death 12 years later a total of £46,800 in interest would have been paid
  • The house is sold and the original £60,000 mortgage loan is repaid out of the proceeds
If we assume average house price inflation of 3% a year the property would be worth £285,000 and so £225,000 (£285k - £60k) could be left to any beneficiaries.

Of course there would be expenses involved when selling the property.

How much can I borrow

The amount you can borrow will depend on two main factors - your age and income. Obviously the value of your house is significant as well.

  • Income - You will need to be able to prove that you have an income that is sufficient to both pay the monthly repayments and also your living expenses.
  • Age - The younger the better. People over the age of 70 might struggle to get approved for an interest only mortgage
Advantages - Interest only Mortgages
  • The loan principal is fixed - Unlike Lifetime mortgages where no interest is paid on the loan (it's rolled up and added to the principal) the original sum borrowed via an interest only mortgage stays the same. So on your death any increase in the value of your home can be passed on to your beneficiaries

  • Flexible - One of the main problems with Equity Release is that it's somewhat inflexible. But interest only mortgages are usually flexible - check to see though if there are any expensive early repayment penalties. See Secret 3 - Buy simple and flexible - you can't read the future - which is one of this site's 10 Secrets to Good Personal Finance

  • Only pay for the time you actually hold the mortgage - If you were to die six months after taking the loan you would only pay interest for the short period

  • Cheaper interest rates - Most banks and building societies offer interest mortgages which means competition is high and that usually leads to competitive interest rates. The rates are therefore so much better than with a specialist equity release deal

  • Portable - Most of these mortgages are portable if you want to move home and this adds to the overall flexibility

  • Available to anyone up to the age of around 70 - Check this though as lenders all have different policies and it can also depend on your personal and financial circumstances

  • If the interest rate is fixed - You always know what your monthly repayment will be, this protects your downside and can help with monthly budgeting

  • The ability to overpay - Most of these mortgages allow overpayments. Useful if you receive windfall cash
Disadvantages - Interest only Mortgages
  • Need an income to qualify - In most situations you won't qualify for one of these loans unless you can prove an income that is both enough to cover the interest repayments and provide for general living expenses

  • Variable interest rates - If you don't fix the interest rate your monthly repayments could rise and fall significantly. Falling rates are obviously not a problem, but what if rates jump by 2%-3% or more over a short period of time - it's happened before in the past

  • Your State benefits might be affected - A cash lump sum received could seriously alter the amount of benefits or state support you're able to collect. It is critical to research this matter further

  • Hefty early repayment penalties - Some mortgage deals are expensive to repay early should you wish to. Check on these facts before signing up as it is important to remain as flexible as possible
LearnMoney.co.uk Comment:
If you have an income which can support both the monthly repayments of an interest only mortgage and general living expenses then these types of loans are the best form of Equity Release - No doubt about it.

Although as indicated before, technically they're not an Equity Release deal per se. People only refer to them as such because in effect they do release equity from a property.

As ever though you're strongly advised not to rush into any financial deal where large sums of money are involved. Remember your house is your major asset. Take plenty of time to fully research the mortgage market paying special attention to how flexible the different deals are and all related charges and fees.

Also don't forget it's the charges and fees where the financial firms often play their sneaky tricks and we consumers lose out - so take plenty of time to research them.

FREE Equity Release Guide

  • This LearnMoney guide offers a simple 5 Step process outlining exactly how to properly research the Equity Release market

  • It make sure you ask the right questions and get proper answers

  • Concentrates on the all-important costs and flexibility of the different Equity Release schemes

  • More details and to download your FREE copy

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