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You Are Here: Home > Personal Finance > Equity Release > Roll Up mortgages
Last update : November 2013
Equity Release: Lifetime Mortgages

What are they - How they work

(sometimes called Roll Up Mortgages)

Equity Release is an umbrella term that covers several different types of loans and strategies, enabling the older generation to release built up equity from their homes while still being allowed to live in them.

The 2 main styles of Equity Release are Home Reversion Schemes and Lifetime mortgages. And under the umbrella of Lifetime mortgages there are 4 separate types of loans including -

How a Lifetime Mortgage works
Lifetime Mortgages (sometimes called Roll Up Mortgages) alongside Drawdown Mortgages (both come under the umbrella term of Lifetime Mortgages) are the most popular form of Equity Release.

A Lifetime Mortgage works like this -

  • A lender offers a cash lump sum, or a monthly income, or a combination of the two which is based on the value of a property
  • Interest is charged on the loan but the customer does not pay it
  • Instead, the interest is added or 'rolled up' on the original loan
  • Interest is therefore compounded over the years (interest is charged on interest etc)
  • On the sale of the property the loan and the compounded interest is repaid

It is critical to note that because compounding of the interest takes place there is a risk that should the loan last a long period of time it could grow larger than the value of the property.

But most Lifetime Mortgages are sold with a no negative equity guarantee. This means that if the loan is greater than the property's value it's a problem for the original lender and not the homeowner.

You can therefore never be forced to sell or move out of your home. See this FAQ for more on the no negative equity guarantee.

How much can be borrowed
This will depend from lender to lender but the following is a good rule of thumb -
  • A 60 year old will be able to borrow around 25% of a property's value
  • And this will rise by 1% every year
  • So a 70 year old should be able to borrow 35% of the property's value and 40% when 75.
Lifetime Mortgage promoters also normally require a minimum loan of £20,000 but again this differs from firm to firm.
An example of a Lifetime Mortgage
  • John takes out a Lifetime mortgage for £45,000 with a fixed interest rate of 7%
  • John passes away 10 years later and his property is sold
  • The lender gets back his original loan value, £45,000 plus the rolled up interest of £43,522 making for a total of £88,522
  • Any value in the property above £88,522 when it's sold is left to John's beneficiaries
Important - How compound interest grows over time

Compound interest is an important point to understand when it comes to Lifetime mortgages.

Compounding means that interest is charged on interest and therefore over time even a small loan can grow to a large one

It isn't so much of a problem in the early stages of a loan, under 5 years. But it starts to take effect after about 10 years. See the following example -

  • A lifetime mortgage of £39,000 is taken out when you are 65 at a fixed rate of 6.95%
  • In 10 years the original loan plus interest will have grown to around £80,000
  • When you reach 80 the debt will be around £112,000
  • In just 15 years the accrued interest bill will be around £73,000
House price growth should also be taken into account

Taken out of context the figures above don't look that good -

  • An initial loan of £39,000 seems to get out of control over 10 years, and in 15 years it stands around £112,000

But when you combine the loan value after 10 or 15 years with natural house price inflation the figures start to take on a different dimension. Yes, property has been hit over the last few years but the values are still sharply higher over 10 or 15 years).

Look for example how much equity would still be available to leave to any heirs after 10 years with 3% house price inflation -

  • A property is worth £130,000 today
  • A Lifetime mortgage is taken out and releases £39,000 with a fixed rate of 6.95%
  • After 10 years the £39,000 has grown to £78,978 but the property has also risen in value to stand at £174,709
  • If the mortgage were to be paid back and the property sold there would still be £95,731 left in remaining equity which belongs to either the owner or his beneficiaries

Take note of this point because it's important. So many Lifetime mortgage commentators seem to miss this, ie they don't consider that over a period of time the property will also probably have risen significantly.

So if you look at just the loan value the figures look dreadful. But take into account house price inflation and they start to make a lot more sense.

Loan repaid
after
Annual House
Price infl. %
Value of
Property
Total Debt
Remaining
Equity
5 Years
0
£130,000
£55,850
£74,150
3
£150,706
£55,850
£94,856
5
£165,917
£55.850
£110,066
10 Years
0
£130,000
£78,978
£51,022
3
£174,709
£78,978
£95,731
5
£211,756
£78,978
£132,778
15 Years
0
£130,000
£111,683
£18,317
3
£202,536
£111,683
£80,853
5
£270,261
£111,683
£158,577

Releasing £39,000 on a house valued
£130,000 Interest rate 6.95% fixed for life
Source: Legal & General Mortgages (12/3/2003)
How old do I have to be to qualify
Lifetime mortgages (remember 'lifetime mortgages' is an umbrella term for different loans including Roll Up mortgages) are widely available from age 60. A few companies will offer them to those aged 55, while others won't do business with anyone under 65.
Fixed or variable Interest Rate

Most Roll Up mortgages come with either a fixed rate of interest or a floating capped rate.

Interest rates obviously move over time and if they move lower that's obviously good news for borrowers. But good news is never a concern when it comes to money and budgeting.

What would happen if the lifetime mortgage was on a floating rate (tracking official interest rates) which then started to rise, and rise dramatically? In this situation the loan and accrued interest could easily get completely out of control.

Having a fixed interest rate solves problems that result from sharply higher interest rates. Yes, a fixed rate also means you cannot take advantage of falling interest rates, but it does mean that you know exactly how interest will build up over the years. And this is important because you're protecting any potential downside.

Capped interest rate deals

A capped interest rate deal tries to offer the best of both worlds. This benefits from falling interest rates but is unaffected should they rise sharply.

For example, the interest rate might be capped at 7%. This means that if official interest rates, those set by the Bank of England, move to 8% or higher the interest rate on your loan won't rise above the 7% cap. But as interest rates fall the rate charged on the mortgage should fall as well.

Lifetime mortgages and negative equity

With a Roll-up mortgage it is theoretically possible, especially if you live a long time, for the initial loan to grow to be more than the value of your home. This is so-called negative equity.

As there is no standard type of Lifetime mortgage the different lenders have different policies to the negative equity effect. A small minority may ask you to start paying the interest on the loan while others may charge your beneficiaries the extra interest after your death.

Clearly critical questions must be asked and understood before any policy is signed.

Look for SHIP branded Equity Release Deals

There is an easy way to protect yourself from the effects of negative equity.

Most equity release providers sign up to the voluntary code of practice known as SHIP, or Safe Home Income Plans. And the dominant guideline in SHIP policies is a No Negative Equity Guarantee.

The guarantee means that both you and your beneficiaries will never have to pay more than the value of your home should it fall through the negative-equity trapdoor. For example -

  • Say a Lifetime Mortgage Roll Up was taken out a long time ago and stood at £150,000
  • But the value of the property was only £140,000, resulting in £10,000 of negative equity
  • If the person was still alive and living in the home there would be nothing the equity release provider could do, ie no eviction
  • However, when the person dies the £10,000 loss would be met by the lender and not by any surviving relatives

The SHIP code of practice is not only excellent news but it sets today's Equity Release schemes apart from the plans originating in the early 1990s. Deals signed then created controversy because of some horrendous negative equity problems. But those days are thankfully long gone.

Advantages - Roll Up mortgages
  • No negative equity guarantee - This means that if the loan ever exceeds the value of your property you are still legally entitled to live there

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

  • More flexible than home reversion plans - particularly from those looking to borrow smaller sums of money. 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

  • More providers = cheaper rates - Lifetime mortgages are by far the most popular type of equity release so there are more providers in the market which creates competition which in turn normally leads to lower interest rates and other assorted charges

  • Portable - most are portable if you want to move home and this adds some overall flexibility

  • Available to those as young as 55 - Whereas Home reversion schemes are normally only available to people over the age of 65, Lifetime mortgages can be obtained when 55+

  • Regulated by the FSA - Always good to have a financial product regulated and monitored by the financial regulator, the Financial Service Authority (FSA)
Disadvantages - Roll Up mortgages
  • Compound interest - Interest is charged on interest and so on. Work on the assumption the initial debt will double after 10 years and then double again after another 10. Take out a lifetime loan for £50k when 60 years old and at 80 it will have mushroomed to £200k

  • Interest rates can be high - Because these are specialist type mortgages the interest rates can often be high in relation to more traditional style mortgages

  • Might not be any value in the property when you pass away - Because of compound interest the loan value could exceed the value of the property when you pass away. Nothing will therefore be available to leave to your beneficiaries

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

  • Might increase your tax - Although the original cash is paid out tax-free if you use this money to generate an income further tax might have to be paid

  • Hefty early repayment penalties - Sign up but want to cancel the deal later and you could find there are expensive early repayment penalties

  • Might not be able to release more equity - depending on how much the initial deal is signed for it might not be possible to release more equity in later years
Where and how to buy - Buying tactics and tips


LearnMoney.co.uk comment:
Roll up mortgages are far from perfect financial products.

Their main negative is that as we never know how long we will live it is impossible to know how large the loan might grow. This is due to the nature of compound interest where interest is charged on interest and so on.

So Equity release plans, including Lifestyle mortgages, should be viewed as a massive financial decision which can have long ranging effects. Notably, unless you take great care of the amount of money that has been released, it is possible that you could end up in extreme poverty in later life.

Sadly this has happened to many people in the past who've fallen for the slick and glossy lifestyle marketing where luxury cruises and new cars are often promoted as areas to splash out on.

But you can rise above that nonsense if you use common sense which includes -

  1. Spend as much time as possible on researching what you're buying and looking carefully at both the charges involved and also the small print
  2. Think long and hard about the most prudent way to use any money released and work on the assumption that you will live for many years
  3. Seriously consider all other financial options including downsizing your property - See Alternatives to Equity Release

Final Thought - Being debt free is later life is something to aim for

Many people borrow money all their lives whether on credit cards or a mortgage etc. So it's not a bad move to head into our twilight years with zero debt and few obligations. But a lifetime mortgage creates yet more debt and a debt that might increase substantially should you live a long time.

It therefore makes sense that Equity Release, including Lifetime mortgages, should be considered only as a last resort.


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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