The profile of homeowners interested in drawing equity out of their home has changed a lot in recent years. The approach today is less focused on the need to raise cash to supplement retirement income and more on practical and viable money management. Indeed, the potential candidate for an equity release scheme is just as likely to be someone in their 50s or 60s as it is someone in their 80s or 90s.

The basic principle remains the same, however: by releasing equity from your property, you get immediate access to some cash to spend, while the equity release provider has a fair chance of getting that cash back, with interest, in the not-so-distant future. Children are often the beneficiaries of equity release these days, with parents looking to use the equity in their homes to fund university fees, student debts or homes for their children as they struggle to get on the housing ladder.

Additional reasons for opting for equity release typically include boosting pensions income, easing inheritance tax liabilities or just having some extra cash to spend. But homeowners are still advised against throwing caution to the wind when turning their bricks and mortar into ready cash.

‘It is not surprising that equity release is becoming popular, as many older people are finding that their income in retirement is inadequate and their wealth is trapped in their property,’ says Gordon Lishman, director general of Age Concern England. ‘However, equity release is a major commitment, and older people should be aware of the pitfalls and make sure they get the right advice. Anyone considering equity release should first check they are receiving all the benefits they are entitled to and explore their other options,’ he advises.

A variety of schemes

As the potential market has widened, so too have the options available and the providers offering them, and the means to release equity from your home will vary depending on which profile you match. There are three main types of equity release schemes:

1. Lifetime mortgages

With a lifetime mortgage, a loan is secured against the property, providing a tax-free cash lump sum. There are no monthly repayments to make, but interest is added to the loan throughout the lifetime of the borrower. There should be options to pay interest at a fixed or variable rate. When the home is sold, the loan and accumulated interest is paid back. In this instance the borrower retains full ownership of their home.

You can get out of a lifetime mortgage, as with any other type of mortgage, but there could be an early repayment charge for doing so. Lifetime mortgages are available to borrowers aged 55 and above.

2. Drawdown lifetime mortgages

This product allows the borrower to take out equity as and when they need it rather than taking the whole amount in one go. The advantage is that the interest is only paid on the amount drawn down each time. However, interest rates can be higher than on a standard lifetime mortgage.

3. Home reversion plans

The tax-free cash lump sum borrowers can get from a property through a home reversion plan is not a loan. In effect, part or all of the home is sold to the home reversion plan provider in exchange for which the seller gets a lifetime lease to stay in their home. When the property is eventually sold, both the homeowner and the reversion plan company share any increase in the property’s value.

An important point to bear in mind is that the homeowner won’t get the full market value of the portion of the house they sell to the reversion company. The latter has to cover the fact that they may not get their share of the property to sell for many years and they are providing rent-free tenancy to the homeowner for the rest of their lives.

Which plan to choose?

When it comes to the pros and cons, as with most things in life, the more you want, the more it will probably cost. For example, you may get more cash from a home reversion plan, but you won’t get the flexibility you would with a lifetime mortgage, which you can switch out of.

Conversely, of course, you pay for the flexibility of a lifetime mortgage with the lower amount you are eligible to withdraw – usually between 18 per cent and 50 per cent depending on how old you are – and you will pay interest on the cash you receive, because it will be deemed a loan. You can, of course, reduce the amount you pay in interest by withdrawing in stages with a drawdown lifetime mortgage, which may suit those who don’t need all the cash upfront.

Advice is essential

If there is any key message, it is that you must take advice from an independent financial adviser (IFA), preferably one with experience of equity release, and from a solicitor. That advice could well be that equity release is not a good idea for you.

‘The reasons are varied but the real answer is that equity release is right when there is an imbedded value in taking out a plan,’ says Dean Mirfin, business development director at Key Retirement Solutions. ‘A clear perceived benefit in doing so needs to be seen, by both the client and the adviser.’

You are advised to select a provider that has accreditation from Safe Home Income Plans (SHIP), the trade association for equity release providers. ‘SHIP membership means many things but ultimately there are a number of guarantees that must be provided,’ says Mirfin. ‘They are the right of tenure for life, the flexibility to move to another property and the no-negative-equity guarantee. Using a SHIP provider ensures that these key concerns are all dealt with.’

A last resort?

There are still those who urge caution and consider equity release to be a last resort. After all, it is your home that is being used to underpin these schemes. Some critics maintain that equity release borrowers don’t get the best out of the deal.

‘The message regarding equity release is that it is one option among many,’ says Mirfin. ‘A decision to speak to a specialist adviser is not a decision to actually do equity release, but to consider it alongside other options.’

That said, SHIP recently showed equity release rates were lower than the average standard variable rate for mainstream mortgages. In May, it highlighted the average rate of interest for the top ten lifetime mortgage equity release providers as being 6.39 per cent, while the average SVR rate for the top ten mainstream mortgage lenders was 7.32 per cent.

‘This counters critics’ claims that equity release lending is prohibitively expensive and an option of last resort,’ says Jon King, chief executive of SHIP. ‘The equity release market is fully regulated by the FSA. With rising standards and the rates highlighted, it has never been safer or cheaper to make use of equity release.’

Consider the future

Whatever form of equity release you undertake, it will mean that you will be leaving less to your beneficiaries. On the other hand, you will also be leaving less in your estate to be potentially subject to inheritance tax.

‘As the house is usually the major part of the estate value, it is difficult to employ some of the more common methods of avoiding inheritance tax, such as gifting the asset away, as the owner still wants to live in it,’ says Nick O’Shea, director of IFA Pharon. ‘If the owner gifted the house and continued living in it, they would have to pay a fair market rent to prove it is not a tax-saving scheme, and that may not be possible.’

Through equity release, money raised can be gifted into a trust and invested for eventual beneficiaries. O’Shea explains, ‘By using the equity release and investing the proceeds in trust for children or other beneficiaries, this has the effect of reducing the estate value on death. The equity release mortgage is a debt on the eventual estate and the investments in trust are not counted in the estate value after seven years.’

This article is from the September 2007 issue of What Investment.