Signing up for an equity-release scheme is an incredibly tricky and emotional decision. There are plenty of solid reasons why you might want to unlock the equity in your property, and plenty of equally solid reasons why this might make you feel uneasy.

In many respects, equity release, sometimes called a ‘home income plan’ or ‘home reversion plan’, looks like a product whose time has finally come. The pension crisis, dwindling annuity rates and the rising cost of essentials such as food, drink, council tax, utilities and petrol have left many elderly people on fixed incomes struggling to meet daily living costs. Yet thanks to soaring property values, millions will be living in homes worth hundreds of thousands of pounds.

This has created a vicious circle, but is unlocking spare cash in your property through equity release really the way to square it? Many profit-hungry commercial organisations certainly think so. Big-name companies regularly enter the market, with Royal Bank of Scotland, NatWest and HSBC launching in recent months, following on the heels of Prudential, Mortgage Express, Bristol & West, Portman Building Society, Standard Life Bank, Norwich Union and Northern Rock.

Plus there are the smaller, long-established specialists such as Hodge Equity Release, Bridgwater Equity Release, Home & Capital Trust, and Stroud & Swindon Building Society.

Some companies front plans sold by specialist providers. Age Concern, for example, sells the Northern Rock product; Saga markets a plan by Scottish Widows.

All are jostling for their portion of what is predicted to be a lucrative market. Baby-boomers are currently sitting on £543 billion worth of housing equity, and this is set to rise to £1,425 billion by 2020, according to a report by Prudential and Datamonitor.

The current market is worth a relatively modest £1.4 billion, but that could double by 2008, according to Safe Home Income Plans (SHIP), the trade body representing equity-release firms. Thereafter, the sky’s the limit.

The trend will accelerate as more and more people bank on using their property to fund their twilight years. Almost 13 million people expect to use their property to see them through in retirement, of which two million will use it to generate more than half their income, according to a new report from Datamonitor.

David Black, report author, lists a host of factors that could drive demand for equity release. He says: “Increasing life expectancy, insufficient pension contributions, declining state pensions, increased taxation, lower interest rates on savings, poor stock market returns, increasing care-home costs and low annuity rates will all increase its attraction.”

Equity release may have massive potential, but even within the financial services industry, many remain suspicious. Perhaps surprisingly, independent financial advisers are among the most sceptical. One in ten don’t like it and a similar number don’t even understand it, while three out of ten don’t like the products available, according to a recent survey by the Association of Independent Financial Advisers (AIFA). The upshot is that two out of three IFAs don’t advise on equity release at all.

The most common fear is that it could become the next mis-selling scandal. Nick Gardner, director at mortgage brokers Chase de Vere Mortgage Management, says the product’s target market of elderly people is potentially vulnerable and easy prey to unscrupulous salesmen. “Your home is your biggest asset, and it’s important every customer takes independent advice and fully understands both the benefits and drawbacks, so that nobody makes an ill-informed decision. Otherwise the fallout could be nasty.”

So how does it work?

Equity release allows you to borrow money against the value of your home, as either a lump sum or regular income, and spend on whatever you like. You don’t have to sell or move, nor will your spouse or partner have to move after you die. The capital and interest are repaid when the house is finally sold, when you either die or move into long-term care.

You can spend the cash on anything you like – home improvements, paying bills, buying a new car or enjoying a holiday, but remember: all that spending comes from your children’s inheritance. There are two main types of plan. The most popular are known as lifetime mortgages, but some may find that home reversion plans suit them better. It depends on your circumstances.

Lifetime mortgages

This is effectively an interest-only mortgage secured on your property. You pay either a fixed or variable rate of interest, which rolls up year after year, until it is finally repaid from the proceeds of your property sale. This type of plan is preferred by larger names such as HSBC, Mortgage Express, Norwich Union, Northern Rock and Prudential.

Plans should be backed by a ‘no negative equity’ guarantee, which pledges you can never owe more than the sale value of your home, no matter how long you live. Check the wording of your guarantee. You can’t borrow the full value of your house, but a percentage based on how old you are. The younger you are, the less you can borrow, because the vendor will probably have to wait longer before getting its money back. Most plans rightly won’t let you borrow until age 60.

How much you can borrow at each age depends on the lender. Mortgage Express, for example, allows a 60-year-old to borrow up to 25 per cent of property value, and this rises by 1 per cent every year, which means a 70-year old could borrow up to 35 per cent. Minimum loan is £25,000.

Watch out: compound interest means that the price of your borrowing quickly rolls up. Mortgage Express would lend a 73-year-old with a property valued at £135,000 a maximum 38 per cent of its value, or £51,300. If he chose the Lifetime Fixed Rate mortgage of 5.99 per cent and lived another 15 years, he would repay a total of £128,181, recovered from the property sale.

Of course, the property will hopefully have risen in value during that time, so there may still be some inheritance left over. Depending on the plan, you can take the money as a lump sum or regular income, or as a combination of the two.

Home reversion plans

These plans have a much lower profile, but don’t ignore them: they might suit you better. It depends on your personal circumstances. Specialist players such as BPT Bridgewater, GE Life, Hodge Equity Release and In Retirement Solutions typically sell these plans. You sell them a percentage of your property and are handed a lifetime lease, which allows you to live rent-free in your home, but as a tenant rather than owner. When you die, the percentage you sold ‘reverts’ to the company.

You won’t receive the full value of the share you sell but a percentage based on age. A 70-year-old raising money on the full value of their £100,000 house might get, say, £40,000. If selling a half share, they may get £20,000. The older you are, the more you get, as your life expectancy is shorter. Many schemes guarantee that if you die shortly after taking out a policy, some of the value you sold will be returned to your estate.

Dean Mirfin, business development director at independent financial advisers Key Retirement Solutions, says home reversion plans may appeal to somebody with no dependants or desire to leave an inheritance, because they can raise maximum cash by selling the full stake in their property. Conversely, they may also appeal to somebody who wants to guarantee an inheritance.

If you sell, say, 50 per cent of your property, the remaining 50 per cent is guaranteed for your beneficiaries,” says Mirfin. “But if you chose a lifetime mortgage and the property market fell, the rolled-up interest could wipe out all remaining equity.”

If property values soar, however, that 50 per cent stake you sold could be worth rather a lot. That’s the chance you take. There is another difference between lifetime mortgages and home reversion plans: the Financial Services Authority (FSA) regulates the former, but not the latter. After a sustained industry campaign, this will change from spring 2007, when home reversion plans will also come under the FSA umbrella.

Making your decision

You may have developed the knowledge and confidence to make your own investment decisions over the years, but think very carefully before going it alone with equity release. There are just so many variables to take into account.

First, check whether you can boost your income from existing sources. Check your eligibility for state benefits such as pension credit and housing and council tax benefit. Every year, billions of pounds go unclaimed, and the government has now issued a single telephone number to make it easier for pensioners to check their entitlement (0800 99 1234). If you already claim state benefits, drawing a large cash lump sum from your property could backfire by hitting your entitlement.

Plans vary greatly, and specialist advice can help you pick your way through all the different options. You can find help online: website Moneyexpert.com lists 48 different products from 18 providers, and found that APRs differ from as low as 5.7 per cent to as high as 8.9 per cent.

The most competitive rates include: Holmesdale Building Society, with two products at 5.7 per cent; Age Concern and Chorley & District Building Society, which charge 5.9 per cent; and GE Life, which charges 6 per cent. (These may only be available if you borrow larger amounts.)

Sean Gardner, chief executive at Moneyexpert.com, says for somebody raising £50,000 against their property, the difference between choosing the best and worst rates could be £1,600 a year. “Someone releasing £50,000 from their home would pay annual interest of £4,450 at 8.9 per cent, compared with just £2,850 at 5.7 per cent with the best buy, and £3,477 at the average 6.95 per cent.”

Growing competition has forced interest rates down in recent years, but rising swap rates have reverse that trend, and there have been nine rate rises in 2006, says Dean Murfin at Key Retirement Solutions.

Rate isn’t the only thing that will affect your choice of plan, says Mirfin. Your own personal circumstances are equally important. “Every borrower is different, which means some plans will be more appropriate than others. Some lenders set their minimum loan amount at £25,000, for example, so if you only want to borrow £10,000, that’s no good for you.”

Similarly, many people taking out equity release hope to repay the loan at some point, perhaps after coming into an inheritance. “They should avoid plans charging hefty early repayment penalties, which can be as high as 5 per cent in the early years,” adds Mirfin

If you are drawing a lump sum, you might not want to take the money all at once. A growing number of companies now offer a drawdown plan, including Norwich Union, Prudential, Just Retirement, Hodge and National Counties. This allows you to unlock an initial sum of money, plus arrange a cash reserve fund that can be released in future. “You can, say, release £10,000 but set up a reserve fund of £50,000. You will only pay interest on the released funds, which gives you quite a saving,” Mirfin says.

You also have to choose between a fixed and variable rate, although Mirfin says in most cases the answer is clear-cut: “More than 95 per cent of borrowers take a fixed rate. You could be borrowing this money for many, many years, and this protects you against spiralling interest rates.”

Given these variables, you should seek independent financial advice, rather than buying a plan direct from, say, your bank or building society, or a lender that has caught your eye. HSBC, for example, is piloting its HSBC Equity Advance Service, which is actually provided by equity-release specialist In Retirement Solutions. Mirfin urges caution. “In Retirement Solutions is a reputable company, but you only get advice on one company’s products, when you should look at the entire market.”

This isn’t to say that if you go direct to a company you will get poor advice and will be coerced into buying a particular product. Stern FSA regulations and the spectre of mis-selling means that most companies tread carefully.

HSBC spokesperson Karen Garner says In Retirement Solutions operates strict acceptance criteria, and only accepts one in five inquiries. “It insists on no fewer than three face-to-face meetings, and sometimes up to six, plus a minimum of three hours’ advice. It strongly encourages family or trusted friends’ involvement, and requires the customer to seek advice from an independent solicitor. Confirmation letters always include a photograph of the visiting adviser.”

You can play it safe by only choosing a plan from a company that is a member of industry body Safe Home Income Plans (SHIP), set up in 1991 to promote safe and reputable equity-release products. SHIP now has 20 members, all of whom must offer a no-negative-equity guarantee. They must also guarantee the right to live in your property for life, move home without penalty, and choose between cash lump sum or regular income payments.

SHIP members cover around 95 per cent of the market, but not every provider has signed up. Scottish Widows is a notable exception. In June, SHIP agreed that members can only accept business from advisers who hold a suitable qualification in lifetime mortgages.

A warning

Equity release has severe critics. The Consumers’ Association’s magazine Which? warns that schemes can be “expensive, inflexible and leave you with little or no equity in your home, severely limiting your choices later on in life”. It can prove a costly way to borrow, particularly if you live a long and healthy life. Somebody borrowing £80,000 against a £350,000 property on a typical lump sum roll-up scheme could repay £256,570 if they lived for 20 years. Or a massive £343,350 over 25 years.

Which? also damns the “irresponsible” way these products are advertised, notably Norwich Union’s suggestion that its scheme could pay for a trip to New York or “something for the family”. If someone took out the minimum £15,000 loan from Norwich Union, they would owe £28,000 after 10 years.

Malcolm Cole, editor of Which?, advises that you think long and hard before committing yourself: “Lenders want to sell you a lifestyle dream, but the reality can be very different. Schemes can turn into a financial nightmare which could stay with you for the rest of your life.”

You should first consider the alternatives, Cole says, such as downsizing to a smaller property or borrowing from your family, and only use equity release as a last resort.

Don’t rush into equity release. This is a massive decision. Your age, state of health, tax position, savings, property value, state benefit entitlement and family relationships will all affect your conclusions. Speak to every family member affected, particularly beneficiaries, and seek advice from a trusted independent financial adviser, accountant or solicitor.