Mortgages  

Going through the roof

    CPD
    Approx.30min

    There are lump-sum plans which – you will have guessed – enable you to borrow a lump sum, but currently the biggest sellers are drawdown plans – accounting for around 70 per cent of the market – which enable you to draw down funds as and when you need it and also to minimise interest costs as you do not borrow all the money upfront.

    The interest costs and how they are calculated are the first major issue for customers to understand when deciding about equity release. Customers do need to repay the loan and that is where the issue of compound interest comes in.

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    It is not a subject that most people are expert in, so the table below helps outline how it works and should help concentrate minds.

    Someone with a home worth £300,000 borrowing £50,000 at an interest rate of 5.09 per cent and paying a fee of £599 will, if they live for 15 years, owe a total of £108,200.39 at the end of the term.

    YearBalance at the start of the yearInterest charged at 5.07%Fees chargedTotal owed
    1£50,000£2,625.83£599£53,224.83
    2£53,224.83£2,762.100£55,986.93
    3£55,986.93£2,905.420£58,892.35
    4£58,892.35£3,056.200£61,948.55
    5£61,948.55£3,214.830£65,163.35
    6£65,163.35£3,381.650£68,545
    7£68,545£3,557.130£72,102.13
    8£72,102.13£3,741.730£75,843.86
    9£75,843.86£3,935.900£79,779.76
    10£79,779.76£4,140.150£83,919.91
    11£83,919.91£4,3550£88,274.91
    12£88,274.91£4,561.030£92,855.94
    13£92,855.94£4,818.750£97,764.69
    14£97,674.69£5,068.840£102,743.53
    15£102,743.50£5,331.86£125£108,200.39

    Their £300,000 house will probably grow in value over those 15 years – past performance is no guarantee of future performance, of course, but in the past 15 years, according to the Halifax House Price Index, average house prices have increased by around 2.5 times so would have outstripped compounding.

    If house prices rise by 1 per cent a year for 15 years the £300,000 house will be worth £348,290 at the end of term.

    However, the compounding effect does mean a loan of £50,000 will more than double over that period which has major implications for any plans to leave an inheritance.

    The Key Features Illustration for any equity release plan makes this clear – and the detail of the document, which typically runs to at least 12 pages, will delve into a wide range of issues which customers need to consider.

    Equity release will generally be for the medium to long-term, but house prices do go down and people taking out equity release plans when prices do not climb will see the impact. If the price of a £300,000 house falls by 1 per cent a year for 15 years it will be worth £258,000 at the end of the term.

    Plans do include the protection of a no-negative equity guarantee – customers or their estate cannot end up owing more than the value of the home at the end of the term. Even if the amount owed at the end of the term is larger than the house value, there is no debt.