All things equity

With substantial increases in UK house prices over the years, people have inevitably built  significant wealth in their properties. Rising house prices throughout much of 2021 meant the total value of UK housing grew by more than £1m every minute, increasing property wealth to £5.2 trillion by the end of the year. As a result of soaring house prices, many people will have large inheritance tax bills looming over their estates.  

What is a lifetime mortgage? 

The main residence is often people’s largest asset and, increasingly, is being used as part of effective later life planning to meet clients’ objectives. The equity release market has grown quickly over the last few years due to improved product offerings and increased consumer protection. Last year, £5bn was withdrawn from properties using equity release. 

A common form of equity release is through a lifetime mortgage, which is available for homeowners aged 55 and over. A lifetime mortgage enables an individual to borrow money secured against the value of their property. Unlike a conventional mortgage, there is no requirement to service the interest during their lifetime; instead, it can roll up against the value of the loan. The outstanding balance is typically only repaid on death or a permanent move into a care home. Importantly, the client remains the legal owner of their property and will benefit from any increase in the property value over time. 

The amount that can be released when taking out a lifetime mortgage is dependent on age (youngest applicant for joint homeowners), the value of the property, and in some cases, lenders might offer higher releases to those with certain past or present medical conditions.

What are the key features of a lifetime mortgage? 

The lifetime mortgage market has changed dramatically over the past decade, and many providers have introduced attractive benefits and safeguarding features on the products they offer. These include: 

• Interest rates – these are fixed for the individual’s lifetime. It is possible to make partial or full interest repayments should the borrower have surplus cashflow and wishes to keep the debt constant. This is completely voluntary. 
• Joint borrowing – if the borrowing is taken out on a joint life basis, the loan only needs to be repaid on the second death or permanent move into a long-term care facility. Therefore, if one borrower dies or moves into care, the remaining borrower retains the right to remain in the property for the remainder of their lifetime and the loan continues on the same terms. 
• Incapacity – if the borrower loses mental capacity during their lifetime, the terms of the loan will remain unchanged, provided they remain living in the property. The attorney or deputy simply acts on their behalf should additional borrowing be required. 
• Lump sum with reserve facility – it is possible to choose between having an initial lump sum only or releasing an initial lump sum plus a reserve facility. Interest is only paid on the initial lump sum. The reserve facility allows easy access to further funds in the future and no interest is paid on the monies in the reserve facility until they are drawn. 
• No negative equity guarantee – the borrower’s beneficiaries will never owe more than the value of the property.  
• Portability – if an individual decides to move home in the future, their lifetime mortgage can be transferred or ported to their new property, providing it meets the lender’s lending criteria. 
• Downsizing protection – if the borrower needs or would like to move to a smaller property in the future, they can repay their loan without facing any early repayment charges if their new home does not continue to meet the lender’s criteria.  
• Partial capital repayments – it is possible to repay up to 10% of the original loan amount every year if the borrower wishes to do so with no early repayment charge. 
• Fixed early repayment charges – so it is absolutely clear how much the borrower will be charged should they choose to pay off the loan early, subject to the provider’s terms and conditions. 

Planning opportunities 

There are several planning opportunities for lifetime mortgages, these include: 

• Interest-only mortgages – clients may have interest-only mortgages coming to an end, with no ability to extend or fully repay without making a large dent in their retirement savings. A lifetime mortgage can simply replace an interest-only mortgage, enabling a client to remain in their home and preserve their liquid assets for cashflow purposes. 
• Retirement planning – suitable for homeowners who may be ‘asset rich and cash poor’ and would like access to additional liquid funds to help their cashflow.  
• Estate planning – suitable for clients with large inheritance tax liabilities and who would like to make gifts during their lifetime without touching their liquid assets. Alternatively, if a client has large pension funds it may be appropriate to leave them untouched due to the inheritance tax benefits and use a lifetime mortgage to fund their retirement expenditure.  
• Long-term care funding – suitable for homeowners wanting to pay for comprehensive care in their own homes.   
• Divorce planning – suitable for homeowners getting divorced and where one spouse wishes to remain living in the matrimonial home. Equity release can be used as part of the settlement to buy one spouse out of the home and is particularly helpful where liquidity may be an issue. 

Estate planning and residence nil-rate band planning  

In the autumn statement 2022, the chancellor announced a freeze on inheritance tax allowances until April 2028. This included a freeze on both the inheritance tax nil-rate band of £325,000 and the residence nil-rate band of £175,000.  

The increase in house prices along with the frozen inheritance tax allowances will see a rise in those being hit with an inheritance tax bill, especially those with significant property wealth. Furthermore, for individuals with a net estate worth over £2m, the residence nil-rate band is tapered by £1 for every £2 over this threshold. Estates (based on a married couple if allowances aren’t used on the first death) with a net value of £2.7m will completely lose any benefit of the residence nil-rate band allowance. This is where an equity release and gifting solution could reduce the value of a net estate below the £2m threshold and fully reinstate their residence nil-rate band, potentially saving thousands of pounds in tax. 

In a recent case, The Private Office helped a man use a lifetime mortgage to release and gift £3m to his children and grandchildren. His property was valued at £9m and therefore the potential inheritance tax bill saving here is over £1.2m, provided he lived for seven years from the date at which the gift was made. Additionally, the fixed interest that accrues on the loan will be a debt on his estate and will reduce the value for the purpose of inheritance tax.  

It is worth knowing that properties with existing trusts attached are not suitable for equity release, as there is not currently a lender on the market who will accept such properties. If the client wishes to proceed with a lifetime mortgage the trust would need to be unwound. If the borrower wishes to release funds to make lifetime gifts, there are not any restrictions on who the gift can be made to. Therefore, the client could gift part or all of the released funds directly into a trust for the benefit of their chosen beneficiaries.  

Releasing part of the equity from a property is not just a solution for those needing some extra capital or cashflow. This can also be used as a tool for estate planning purposes. A lifetime mortgage and gifting arrangement allows people to reduce the value of their estate, which could be subject to inheritance tax. This means that more of their hard-earned assets can pass tax efficiently to the next generation. It also means that liquid assets, such as cash and savings, remain untouched and are available to fund expenditures for the remainder of their lifetime. 

Potential disadvantages of a lifetime mortgage 

Holding cash deposits rather than equity in a property can affect the benefits a person is entitled to – for example, pension credit and universal credit. So, if a client is entitled to benefit payments, it is important to check the impact of releasing equity from a property before completion. If they are unsure, they should ask an equity release adviser to confirm what, if any, impact there would be. 

By releasing equity from a person’s property via a lifetime mortgage, interest is charged for the period of their lifetime, and this can be expensive, especially when opting for the interest to be rolled up (through compound interest). As a result, this will have a direct impact on the overall value of their net estate, potentially reducing the amount remaining for their beneficiaries.  Therefore, we strongly recommended that clients involve their families when considering equity release. 

There are fees associated with taking out a lifetime mortgage and the precise amount will depend upon the client’s personal circumstances. To understand the features and risks of a lifetime mortgage, a client will be provided with a personalised illustration. The Financial Conduct Authority does not regulate taxation advice, inheritance tax planning or trusts.