How Much Does a Lifetime Mortgage Cost?
If you have no choice about how to raise funds, it is important to understand how to minimise the costs involved with taking out a lifetime mortgage.
Where the money is not needed for essential expenditure, deciding whether the borrowing represents good value for money might be important.
Why might you consider a Lifetime Mortgage?
Equity release is a general term describing options available to people over a certain age who want to make use of the value locked up in their home.
One option might be to sell all or part of the property to a suitable provider - this is called a Home Reversion Scheme. The applicant receives a heavily discounted lump sum and remains entitled to live in the property for their lifetime or until poor health means they need full-time residential care. Many people feel that the disadvantage is that they have to give up ownership of their home. If this appeals to you, give us a call.
The alternative is known as a Lifetime Mortgage. In this option, the homeowner remains in possession of their property and the lender is entitled to recoup what is owed from the future sale of the house.
It enables the borrower to some flexibility in managing the amount that is going to be paid back and might allow the property to be inherited by a family member who is happy to deal with the debt. Although it is more flexible, potential borrowers must understand the costs involved in making the arrangement.
Initial costs for a Lifetime Mortgage
Check that the adviser or their firm is affiliated with the Equity Release Council, they do not determine costs but they do ensure that the adviser is properly qualified and deals with you in a way that complies with their overarching principles and provides the right customer outcomes.
Before you commit to dealing with a particular adviser, they will explain their services and costs. You should be sure you understand what adviser fees are payable and when, and if anything is refundable under any circumstances.
A solicitor will be required to carry out the basic legal work on behalf of the lender and the cost falls to you. However, the solicitor will also comply with the requirements of the Equity Release Council, one of these is an independent check that you understand the implications of the Lifetime Mortgage and you the adviser is not taking advantage of any misunderstanding.
Some specialist Equity Release solicitors will charge a fixed fee for most work, but this may increase if the property is leasehold, or if it is a large loan. You can get a quote in advance. If you have anyone living with you who is not going to be on the mortgage, they may be required to find independent legal advice about their situation, and this will be an extra cost.
There might be an arrangement fee and valuation fee although these are usually swallowed by the lender. All of these fees can usually be added to the amount being borrowed, but beware that this might affect the interest being paid.
Lifetime Mortgage Interest Rate Calculation
Different lenders will have individual thresholds for charging interest rates, but they will all be based on the amount being borrowed compared with the property value, known as the Loan-to-Value or LTV, and the age of the youngest applicant.
For example, if there are two separate applications for people wanting to borrow £100,000 against a property worth £400,000, the loan to value will be 25%. The interest rate payable by a 66-year-old applicant is likely to be higher than the interest rate payable by a 75-year-old applicant. Therefore, if you are prepared to be flexible, you might save significant amounts in future interest payments by reducing the loan to below the best lender's LTV threshold.
The picture is affected by any reserves set aside for future drawdown. For example, an immediate requirement for a loan of £100,000 plus a drawdown reserve of £100,000 would be 50% LTV on a property worth £400,000. Although you would pay interest only on the initial withdrawal until the further money was borrowed, this is likely to be at a higher interest rate than if no drawdown is included.
It is important to take account of future needs, but the reserve should be included because of likely need rather than as a nice to have.
One option that also affects the interest rate of a Lifetime Mortgage is the inclusion of a capital guarantee. Some lenders will allow you to reserve a minimum amount payable to your estate in the future. However, in doing this, they reduce the property value available to the LTV.
For example, under normal circumstances, a loan of £100,000 on a property worth £500,000 would be 20% LTV. If the applicant wanted to apply a guarantee of £200,000 it would reduce the equity available for borrowing to £300,000 and a £100,000 loan would be 33.3% and therefore likely to be at a higher interest rate.
Lifetime Mortgage Early Repayment Charges
When lenders set out their rates, they expect to achieve a minimum return on their investment with borrowers. If loans are repaid in advance of the life events which would normally lead to the contract coming to an end, they must be able to recoup some of the money they would have earned and they do this by applying an Early Repayment Charge.
Most lenders offer the option to cover all of the interest due plus 10% of the outstanding capital every year. There may be other options in the market that allow higher levels of repayment, but these will come at a higher cost so be very sure you want to make use of them before signing up. If there is a chance that you might suffer early repayment charges, the method of calculation becomes important.
Some lenders charge a fixed amount which is a percentage of the amount being overpaid. For example, if the charge is 5% and the amount being repaid exceeds the 10% allowance by £20,000, the early repayments charge will be £1,000. The fixed amount often reduces over time and will usually expire after approximately 10 to 12 years.
Other lenders calculate the early repayment charge based on changes in the UK Gilt Rate. This is effectively the cost of borrowing money elsewhere. It isn’t possible to predict the actual charge because it will vary under different investment conditions. It could be cheaper for the borrower than a fixed charge or it could be as high as 25% of the amount being overpaid.
Keep in mind that if you will not have sufficient income or future lump sum to settle the mortgage early, or if you would want to hold on to any future funds, then the early repayment charge is irrelevant. You should choose the cheapest rate of interest rate regardless of the type of early repayment charge levied by that lender.
Avoiding future charges
The really important thing is to understand what costs are involved to evaluate the benefits of borrowing the money. If the funds are being raised as a gift for beneficiaries, they might well be very happy to suffer the reduction in their inheritance in return for a lump sum when they need it most.
If you are using the funds for your benefit, try to foresee how your income and expenditure might change in the future so that you can avoid having to borrow extra money in future.
If you have any questions about how an Equity Release works, please get in touch. There is no cost or obligation on your part if we have a chat about your needs and at least you will be better informed about your options.