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. This is not a popular way of releasing funds. Many people are not willing to give up ownership of the home they worked so hard to acquire but 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 records a charge against the property at the land registry, much the same as the residential mortgage that people have held before. It allows the lender to recoup what is owed from the future sale of the house.
A Lifetime Mortgage enables the borrower some flexibility in managing the debt and reducing the future cost to their estate. For example, they can pay all or part of the interest as it falls due, rather than increasing the amount to be paid back. They can even repay some of the capital borrowed although there are additional charges for repayments over a certain amount. Although it is more flexible, potential borrowers must understand the costs involved before entering into a Lifetime Mortgage.
Initial costs for a Lifetime Mortgage
You should check that the adviser or their firm is affiliated with the Equity Release Council (ERC). Although they do not determine costs, the ERC does ensure that the adviser is properly qualified and complies with their principles which include ensuring you enjoy the most suitable 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 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 could lead to extra costs.
There might be an arrangement fee charged for the particular mortgage. There may also be a valuation fee although these are usually swallowed by the lender. These fees can usually be added to the amount being borrowed but check whether these extra amounts lead to an increase in the interest rate you will be charged.
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. This is known as the Loan-to-Value or LTV and is calculated using 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 interest rate is also affected by any reserves included 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.
Since it adds to the cost, the reserve should be included when you are likely to need to make use of it in future 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 protect a minimum inheritance which will be payable to your estate in the future. To make this work, they reduce the property value available by the amount of guaranteed protection when calculating 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 guarantee that £200,000 would be available to their estate, it would reduce the equity available for borrowing to £300,000. In turn, a £100,000 mortgage would represent an interest rate of 33.3% instead of 20% and the rate of interest would increase. Consequently, a measure put in place to protect inheritance is actually likely to reduce the amount available after the mortgage is repaid.
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 you the option to pay all of the interest due every year plus 10% of the outstanding capital. 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 between 8 and 15 years after the start of the Lifetime Mortgage.
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.
The chosen lender may offer both types of early repayment charge and the adviser will discuss the most appropriate with you based on your willingness to take a risk.
Keep in mind that if is not enough income to make capital repayments and you do not expect to receive any lump sums 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 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 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 so that you can avoid having to borrow extra money in future. Where you predict that additional equity release is likely to be needed, it may be more cost-effective to set up a drawdown facility than have additional advice fees for a further advance or remortgage.
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.