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Equity Release: Drawdown Mortgages

What are they - How they work

(A subset of a Lifetime mortgage)

Drawdown mortgages and
Roll Up mortgages (both come under the umbrella term of Lifetime Mortgages) are the most popular form of Equity Release.

The main features of a Drawdown Mortgage are -

  • A lender will agree to release a sum of money based on the value of your home
  • Interest is charged on the loan but the customer does not pay this - it is added to the value of the original loan
  • Interest is therefore compounded over the years (interest is charged on interest etc)
  • Usually a small cash lump sum if taken when the deal is signed and then subsequent amounts are withdrawn as necessary
  • On the sale of the property the loan and the compounded interest is repaid
An Example -
  • A Drawdown Mortgage for £50,000 is agreed against the value of your property
  • £5,000 is taken immediately as a cash lump sum
  • Another £5,000 is withdrawn 14 months later
  • And a further £4,000 9 months beyond that
  • Further amounts of £5,000 are withdrawn over time until the full £50,000 has been withdrawn

The difference between the two main types of Lifetime Mortgages is therefore -

  • Roll Up Mortgage - A cash lump sum is taken for the whole amount when the deal is first signed - More on Rollup Mortgages

  • Drawdown Mortgage - A much smaller cash lump sum is taken when the deal is signed and then further amounts are withdrawn when necessary
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
  • The amount will rise by around 1% every year
  • So a 70 year old should be able to borrow 35% of the property's value and 40% when 75

Drawdown mortgage lenders also normally require a minimum loan of £20,000 but again this differs from firm to firm.

Important - How compound interest grows over time

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

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

However the effects of compounding aren't as severe with a Drawdown mortgage as they are with a Roll Up mortgage.

This is because interest is only charged on money when it is actually withdrawn. So if you were to agree to release £50,000 from your property, but this was withdrawn in stages over a 5 year period, the interest bill and in turn size of the loan would not be as high as if the £50,000 was taken in one cash lump sum.

The table below shows the difference in the compounding effect between using a Roll Up Mortgage to release equity in a property or using a Drawdown mortgage.

Difference between interest charged on a Roll Up Mortgage and a Drawdown one

Difference between interest charged on a Roll Up Mortgage and a Drawdown one

  • £50,000 is released via a Roll Up mortgage and is therefore taken as a lump sum - interest is charged and compounded on the full amount from day 1
  • The Drawdown mortgage releases an initial £25,000 on day 1 and then draws down £5,000 in years 2, 4, 6, 8 and 10 for a total amount of £50,000
  • The interest rate for both deals is fixed at 5.99%

As you can see it is far more beneficial and ultimately cheaper to drawdown money over a period of years rather than in one larger lump sum.

House Price Inflation should be taken into account

The main downside to any loan where compound interest is at work is that it can start to grow extremely large as the years go by. The effect is somewhat negligible in the early years but after 10 years the interest bill can start to grow dramatically.

But when it comes to Lifetime Mortgages, including Drawdown loans, natural house price inflation should be taken into account. Yes, of course property prices can go down in value but over longer periods of time expect them to rise.

  • A property today that is valued at £150,000 with an average of 3% annual house price inflation will be worth around £202,000 in 10 years
  • £234,000 in 15 years, and
  • £271,000 in 20 years
So when you look at how large a Lifetime Mortgage might become over a set period of time also consider natural house price inflation as it will make more sense of the figures.
Advantages - Interest only 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

  • 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 various 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 - Interest only Mortgages
  • Compound interest - Interest is charged on interest and so on. But a Drawdown mortgage is far better value than a Roll Up one as money is only drawn down when it's needed rather than in one lump sum. Still, compounding interest will be at work with drawdown mortgages

  • 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 on your death - Because of compound interest the loan value could exceed the value of the property when you die. Nothing will therefore be available to leave to your beneficiaries

  • State benefits might be affected - money received from 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 the income tax you pay - 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

  • Sheltered accommodation - Many ER providers won't lend against warden assisted sheltered housing or retirement flats. So if you want to move to such a property you would have pay back the amount owing to the original lender and then try to find a second ER deal which of course would incur further fees

  • 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:
The two main Lifetime Mortgages are Roll Up and Drawdown mortgages, both of which are far from perfect financial products. The main negative with both styles 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.

But, drawdown mortgages go some way to diluting the negative effect of compound interest by agreeing a cash amount to release from a property and then taking this amount in stages. Perhaps £30,000 is available with £5,000 being taken straight away and then another £5,000 per year for the next 5 years. Interest is only charged as and when money is withdrawn.

So for this reason drawdown mortgages are far superior to Roll Up mortgages.

But, all Equity Release schemes 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 Drawdown 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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