Making an Informed Decision in Retirement
As homeowners approach retirement, they could find themselves facing crucial financial decisions. If you find yourself considering equity release it is likely you will have considered downsizing to a smaller property in order to free up equity tied up in your property.
Both equity release and downsizing can unlock the wealth tied up in your property. They come with their own set of advantages and disadvantages and it’s important you consider them carefully. A good equity release adviser will discuss with you other alternatives to equity release including:
– whether you could utilise any existing savings
– if you could ask family for financial assistance
– whether you could take in a lodger through the government’s ‘Rent a Room Scheme’, under which income of up to £7,500 could be tax free per year
– If you have any pensions which haven’t been accessed
– whether you could apply for unsecured borrowing
– if you could consider taking a traditional residential mortgage
In this article we’ll explore the pros and cons of equity release versus downsizing, your equity release adviser should discuss this with you and document your discussion in the recommendation provided to you, irrespective of whether down-sizing is a viable option for you.
Equity Release: Pros and Cons
Some Pros of Equity Release:
- Access to Tax-Free Cash: Equity release enables homeowners over the age of 55 to access the value tied up in their home. This can provide a source of funds to support your retirement lifestyle or to cover medical bills, home improvements, make a gift to family or friends, pay off a mortgage or enhance your quality of life.
- No Monthly Repayments: With most lifetime mortgages*, homeowners are not required to make monthly repayments (but you can make them if you wish to). Not having to make payments relieves the financial obligation of regular payments. However, the loan will increase over time as interest is added, reducing the value of your estate. The loan, along with the interest accrued, is typically repaid when the property is sold, this is usually when either the homeowner moves into long-term care, or passes away.
- Maintain Ownership of Your Home: Perhaps one of the most significant advantages of equity release is that it allows homeowners to continue living in their homes. This provides a sense of security and familiarity, which is particularly important as people grow older.**
- Tax-Free Funds: Money released from your home through equity release is typically tax-free at the point it is received.
- Flexible Options: Equity release comes in various forms, including lifetime mortgages and home reversion plans. This allows homeowners in conjunction with their equity release adviser to choose a plan that best suits their specific needs and financial situation both now and in the future.
- Protection Against Negative Equity: Some lifetime mortgages offer protection against negative equity, ensuring that you, or your estate, will not owe more than the value of your home. This is provided that you adhere to the terms and conditions of your lifetime mortgage and your home is sold for a fair market value. All lifetime mortgages which are endorsed by the Equity Release Council will have a no negative equity guarantee.
- Future House Prices: With a lifetime mortgage you continue to own 100% of your property and so you benefit from any future house price growth.
Some Cons of Equity Release:
- Reduced Inheritance: Equity release will reduce the amount of inheritance you can leave to the beneficiaries of your will. By accessing your home’s value, you are essentially reducing the financial legacy you might have otherwise passed on. This can be limited by making payments back to a lifetime mortgage, which you can do penalty free, subject to certain limits. Early repayment charges may apply above a set value.
- Impact on Means-Tested Benefits: Depending on the amount of equity you release, it could affect your eligibility for means-tested benefits, such as state pension credits or universal credit. This can have implications for your overall financial situation and a good equity release adviser should discuss this with you.
- Accruing Interest: With lifetime mortgages, if payments aren’t made, interest is added periodically to the borrowed amount, leading to the accumulation of debt. Over time, this compounding interest can significantly reduce your equity and the value of your estate, limiting the inheritance you can leave behind.
- Early Repayment Costs: If your circumstances change, and you decide to repay the equity release loan earlier than planned, you could incur early repayment penalties (an ‘early repayment charge’) and in some cases these can be substantial. These penalties can be a significant drawback if you need to terminate the arrangement prematurely. There are 2 types of early repayment charge, Defined and Variable. These are covered in a separate article.
- Complexity and Fees: Equity release plans can be complex and often come with various fees, including arrangement fee, advice fee and legal fee. It’s essential to fully understand the terms and associated expenses of the chosen plan before proceeding.
- Impact on Future Housing Needs: Releasing equity ties up a portion of your property’s value. This may limit your flexibility in addressing future housing needs or preferences, as you may not have the same resources available to move or downsize.
- Effect on Future Care Needs: While you can continue living in your home after releasing equity, this may restrict your ability to access certain care services. If you require specialised care in the future, the equity release arrangement may mean there is not sufficient funds to cover those costs.
Downsizing: Pros and Cons
Some Pros of Downsizing:
- Release a Lump Sum: When you downsize, you sell your current home and purchase a smaller, less expensive property. The difference between the sale price of your old home and the purchase price of the new one can result in a substantial lump sum of cash that you can use as you see fit.
- Reduced Ongoing Expenses: A smaller home typically means reduced ongoing expenses, such as utility bills, maintenance costs, and potentially lower council tax. This can free up additional funds for retirement living or other expenses.
- Simplification: Downsizing often means decluttering and simplifying your life. Moving to a smaller space can lead to less physical and emotional clutter, making your life more manageable.
- Accessibility: Moving to a different property could help if your mobility is limited meaning you can have a better and more comfortable quality of lifestyle.
- Potential to Relocate: Downsizing provides the opportunity to relocate to a different area or neighbourhood, which may be desirable for a change in lifestyle or to be closer to your family.
- Maintain Financial Legacy: By selling your property and purchasing a smaller one, you can retain more of your home’s value to pass on as an inheritance to your loved ones.
Some Cons of Downsizing:
- The Stress of Moving: Moving can be a stressful and emotional process, particularly if you’ve lived in your family home for many years. The emotional toll of leaving familiar surroundings and memories can be significant.
- Costs of Moving: Downsizing involves costs which are not insignificant and can include estate agents fees relating to selling your current home, the purchase of a new home, stamp duty land tax, solicitor’s conveyancing fees, hiring a removal company or storage fees. These expenses can eat into the financial gain from downsizing.
- Potential for a Smaller Home: In many cases, downsizing means moving to a smaller property, which may not be suitable if you have specific lifestyle requirements or if you’re used to more space.
- Change of Circumstances: Once you have downsized, should you find the property doesn’t meet your needs, upsizing could prove difficult (particularly, if you have spent the funds gained when downsizing).
- Location Changes: If you decide to move to a different area or neighbourhood when downsizing, it may impact your access to family, healthcare, social activities, or other amenities that are important to you.
Comparing Equity Release and Downsizing:
Financial Gains: Both equity release and downsizing can provide financial gains, but the mechanisms are different. Equity release allows you to access cash from your current home without moving. In contrast, downsizing involves selling your existing property and purchasing a smaller one. The financial outcomes of each option depend on individual circumstances and property values over time but downsizing would avoid the cost of any interest.
Inheritance Considerations: Equity release can reduce the inheritance you leave to your beneficiaries, as it uses a portion of your home’s value and charges interest over the term which can compound if you choose not to make payments. Downsizing can potentially preserve more of your property’s value to pass on as an inheritance.
Ongoing Committed Expenditure : Equity release generally does not require monthly repayments, while downsizing can lead to reduced ongoing expenses due to a smaller property.
Impact on Housing Needs: Equity release allows you to stay in your current home, while downsizing involves moving to a new property. You should consider the potential implications for your future housing needs, lifestyle, and location preferences.
Complexity and Initial Costs: Equity release plans can be complex and come with various fees, but they don’t involve the costs of selling and purchasing a new property, which is an integral part of downsizing.
Making an Informed Decision
There is no one-size-fits all answer to the question of whether you should release equity or downsize.
The decision between equity release and downsizing is a pivotal choice that can significantly impact your financial well-being and quality of life in retirement. Each option comes with its unique set of advantages and disadvantages, and your choice depends on your individual circumstances and priorities. Always seek advice from a qualified equity release adviser and conduct thorough research to ensure you make an informed decision that aligns with your financial goals, housing preferences, and future needs. Both equity release and downsizing can be effective tools to unlock the wealth tied up in your property, and with careful consideration, you can select the option that best suits your retirement and future plans.
*Equity release may involve a home reversion plan or a lifetime mortgage, which is secured against your property and will reduce the value of your estate and impact funding long-term care. To understand the features and risks, ask for a personalised illustration. Equity release requires paying off any existing mortgage. Any money released, plus accrued interest would be repaid upon death, or moving into long-term care.
**You only continue to own your own home with a lifetime mortgage.
