Guide to Equity Release - Laura Brady, Personal Finance and Property Journalist

Releasing equity from your home in simple terms is when you extend your current mortgage against the increased value of your home to release money. You can do this by taking a further advance with the same lender or by remortgaging to a different lender, and you repay this extra borrowing over time along with the original amount you borrowed.

By contrast, Equity Release schemes are designed for older homeowners who have already paid off their mortgage or have a very small mortgage outstanding. (Where there is an outstanding mortgage, this must be repaid out of the money received from the Equity Release product.) These homeowners may be short of disposable income but, due to rising house prices over the years, find themselves owning a highly valuable property. Figures from the Council of Mortgage Lenders' Housing Finance journal (April 2006) show that the over 65s are collectively sitting on over £1 trillion of unmortgaged equity in property. Equity Release schemes are designed to unlock some or all of this equity and turn it into a tax-free lump sum or regular payments, or in some cases, a mixture of both.

There are two different types of equity release products:

1. Lifetime mortgages

A lifetime mortgage is where you take out a loan against a certain proportion of the value of your property - usually between 20 and 50 per cent. The older you are the higher percentage you will be eligible to borrow. The loan is not paid back within your lifetime or while you are living in your home. Instead, when you die or move into permanent care, the loan, plus any interest that has built up on it, will be repaid, usually from the proceeds of the house sale. Interest rates can be fixed or variable depending on which provider you go with.

Because interest payments are not repaid each month, as they are on a conventional mortgage, the interest will accumulate over the life of the loan. The result is that the actual amount charged by the lifetime mortgage provider will not be known when you initially take the product. It will depend on how long you live in your home; in other words the length of time that you have the loan. This could, in some circumstances, mean that the entire value of your home is repaid to the provider leaving nothing to your children.

However, many providers allow you to protect a percentage of the value of your house so you can be sure of leaving an inheritance. This percentage won't be touched when the loan is repaid, as long as any conditions set by the mortgage provider are observed.

The majority of lifetime mortgages also come with a 'no negative equity' guarantee. This means that if you live longer than expected, or even if house prices go down, the amount owed will never exceed the open market value of your home when it comes to be sold. It is, therefore, important to make sure that your lifetime mortgage provider offers this sort of guarantee.

Some lifetime mortgage providers offer 'drawdown' facilities. These allow you to 'keep back' some of the lump sum that you qualify for in a reserve account; rather like an overdraft facility. You can access these additional funds at any time but will only start being charged interest on them when they are released. In short, a drawdown could be a cost-effective way to maximise your options.

2. Home reversion plans

A less popular option is the home reversion plan. This is where you sell all or a proportion of your property to the plan provider rather than taking out a loan against its value. How much you can sell will vary according to your age but, with this type of scheme, the maximum extends to 100 per cent of your property. You can take the money as a lump sum, a regular income or both.

As a home reversion plan is a sale and not a loan, there is no interest to pay. Instead, the home reversion provider will pay less for the relevant proportion of your home than it would be worth on the open market. Typically you will receive between 35% and 60% of its market value depending on your age. So, for instance, if you sold 50% of a £200,000 property you could receive between £35,000 and £60,000 rather than £100,000.

The same percentage of the property's value will then be paid to the home reversion provider when the property is sold. If house prices continue to rise, this percentage will result in a larger sum being paid than the original amount advanced to you.

Getting prepared

Equity release providers usually encourage you to seek professional legal and/or financial advice before signing up to a scheme. Your financial adviser should discuss your circumstances in detail to find out if an equity release product is suitable for you. They should also provide you with a personalised key features illustration and a suitability letter.

Your family should also be closely involved, as it is they who will be most affected in terms of any potential inheritance. And, remember that any cash lump sum or regular payments you receive from an equity release plan could affect your entitlement to means-tested benefits.

While every care has been taken to ensure the accuracy of statements made in this article, no responsibility can be taken for errors/omissions. The views expressed here are not necessarily those of the bank.

Find out more about NatWest's Lifetime Mortgage.