Equity Release Interest Rates and Costs

Main guide

How do equity release interest rates work?

With a lifetime mortgage, the lender charges interest on the money you borrow.

Unlike a standard repayment mortgage, you do not usually have to make monthly repayments. Instead, the interest can be added to the loan. This means the balance may increase over time.

The loan and interest are usually repaid when the last borrower dies or moves permanently into long-term care, normally from the sale of the property.

The interest rate matters because it affects how quickly the balance grows. However, the rate alone does not tell you whether a plan is suitable.

A suitable recommendation should also consider:

• how much you need to release
• whether you need the money now or in stages
• whether you want to make voluntary repayments
• early repayment charge rules
• whether you may move home later
• how the plan affects inheritance
• whether means-tested benefits could be affected
• whether alternatives are available
• the overall flexibility of the product

You can read more about the basics here: How Does a Lifetime Mortgage Work?

What is rolled-up interest?

Rolled-up interest means the interest is added to the loan instead of being paid each month.

For example, if you borrow money and make no repayments, the interest for the first year is added to the balance. In later years, interest may be charged on the original loan and on the interest that has already been added.

This is known as compound interest.

Compound interest can make the balance grow more quickly over time. The longer the lifetime mortgage runs, the more important this becomes.

This is one of the main reasons equity release needs careful advice. A plan that looks affordable at the start may have a much larger balance after 10, 15 or 20 years if no repayments are made.

What is compound interest?

Compound interest is interest charged on interest.

With a lifetime mortgage, this can happen when interest is added to the loan rather than being paid. Each year, the balance may increase, and the next year?s interest may be calculated on the higher balance.

A simple way to think about it is:

• Year 1: interest is charged on the original loan
• Year 2: interest may be charged on the original loan plus Year 1 interest
• Year 3: interest may be charged on the original loan plus previous interest
• Later years: the balance can continue to grow if no repayments are made

This does not mean equity release is always unsuitable. It means the cost needs to be explained clearly before you proceed.

Your adviser should show you a personalised illustration so you can see how the loan balance could grow over time.

Why does the interest rate matter?

The interest rate affects the speed at which the loan balance grows.

A higher rate can mean the debt increases faster. A lower rate can reduce the long-term cost, but it does not remove the risks of equity release.

The final amount owed will depend on:

• the amount borrowed
• the interest rate
• whether the rate is fixed or capped
• whether you make repayments
• whether you take a lump sum or drawdown
• how long the plan runs
• any fees added to the loan
• whether additional borrowing is taken later

Small differences in rate can make a meaningful difference over a long period. However, choosing a plan solely because it has the lowest rate can be a mistake if it lacks features you need.

Are lifetime mortgage rates fixed?

Many lifetime mortgages offer fixed interest rates for life. This means the rate charged on the money borrowed does not change, provided the plan terms remain the same.

Some products may offer capped rates. A capped rate can vary, but it cannot go above a set limit.

Fixed or capped rates can provide certainty, but you still need to understand how interest builds up if it is not paid.

For drawdown lifetime mortgages, future withdrawals may be charged at the rate available at the time you take the money, not necessarily the rate that applied to the original release. This depends on the lender and product terms.

This is important because a drawdown reserve gives flexibility, but future borrowing terms may not always match the initial terms.

What affects equity release interest rates?

Lifetime mortgage rates can be affected by several factors, including:

• market interest rates
• lender funding costs
• gilt yields and wider economic conditions
• your age
• property value
• amount borrowed
• loan-to-value
• product features
• repayment flexibility
• early repayment charge structure
• drawdown options
• health and lifestyle factors
• lender criteria

Two homeowners may be offered different rates even if their properties are worth similar amounts. The product chosen, loan size, age and plan features can all make a difference.

What fees and charges can apply?

Equity release costs vary depending on the adviser, lender, solicitor and product.

Possible costs may include:

• adviser fee
• lender arrangement fee
• application fee
• valuation fee
• solicitor fee
• completion fee
• funds transfer fee
• early repayment charge
• additional borrowing fee
• interest added to the loan

Some fees may be paid upfront. Others may be added to the loan. If a fee is added to the loan, interest may be charged on that fee too, which increases the long-term cost.

You should always ask which fees apply, when they are payable and whether they can be added to the loan.

The biggest cost is often not the set-up fee. It is usually the interest over time.

What is an early repayment charge?

An early repayment charge is a fee that may apply if you repay a lifetime mortgage earlier than expected.

This could matter if you:

• sell your home
• repay using savings
• receive an inheritance
• remortgage to another plan
• move in with family
• move to a property the lender will not accept
• decide later that you no longer want the plan

Early repayment charge structures vary. Some are fixed for a set period. Some reduce over time. Some may be linked to wider market conditions. Some products may offer features that reduce or remove charges in specific situations, such as after a borrower dies or moves into care.

You should not assume you can repay a lifetime mortgage at any time without cost.

Before applying, ask:

• how long early repayment charges apply
• how they are calculated
• whether they reduce over time
• whether there are exemptions
• what happens if one borrower dies or moves into care
• what happens if you downsize
• what happens if you move home
• whether voluntary repayments are allowed without charge

Can you make repayments to reduce the cost?

Many modern lifetime mortgages allow voluntary repayments, subject to lender rules.

This can help control the balance and reduce the amount of interest that rolls up.

Repayment options may include:

• paying some or all of the monthly interest
• making occasional lump sum repayments
• repaying a percentage of the loan each year
• setting up regular voluntary payments
• making repayments without a formal monthly commitment

The exact rules vary by lender and product. Some plans allow repayments up to a certain percentage each year without early repayment charges. Others may have different limits.

Making repayments can be useful if you want to reduce the long-term cost or protect more equity for your family.

However, you should only commit to payments you can afford. If your income is uncertain, a voluntary repayment option may be more flexible than a required monthly payment.

Can drawdown reduce the cost?

A drawdown lifetime mortgage can reduce the amount of interest that builds up if you do not need all the money at once.

With a lump sum lifetime mortgage, interest usually starts on the full amount from completion.

With a drawdown lifetime mortgage, you take an initial amount and keep a reserve for later. Interest is usually charged only on the money you have actually released, not on the unused reserve.

For example, if you need £30,000 now and might need another £20,000 later, a drawdown plan may be more cost-effective than taking £50,000 upfront, depending on the terms.

This is because the unused £20,000 is not usually accruing interest while it remains in reserve.

However, drawdown is not always the best option. Future withdrawals may depend on the lender?s rules and the reserve remaining available. The interest rate on future withdrawals may also be different from the initial rate.

Read more here: How Much Equity Release Can I Get?

Should you choose the lowest interest rate?

Not always.

A low interest rate is important, but it is not the only factor.

A plan with a slightly higher rate may be more suitable if it offers features you need, such as:

• better voluntary repayment options
• more flexible early repayment charges
• drawdown access
• downsizing protection
• inheritance protection
• portability
• better treatment for joint borrowers
• product terms that suit your future plans

For example, if you think you may move home in the future, the portability and downsizing rules may matter more than a small difference in interest rate.

If you want to reduce the balance over time, repayment flexibility may be especially important.

A good recommendation should explain why the selected product is suitable, not just why the rate is competitive.

How do fees affect the total cost?

Fees can affect the total cost in two ways.

First, there is the immediate cost of setting up the plan. This may include advice, lender and legal fees.

Second, if fees are added to the loan, they may increase the balance on which interest is charged.

For example, adding a fee to the mortgage can avoid paying it upfront, but it may cost more over the long term because interest may be charged on it.

This does not mean fees should never be added to the loan. It simply means the effect should be explained clearly.

You should ask your adviser to show:

• fees paid upfront
• fees added to the loan
• interest charged on added fees
• total projected balance over time
• effect on remaining equity
• whether alternative products have lower or higher overall cost

What is the difference between AER and MER?

You may see different interest rate terms on equity release documents.

AER usually stands for Annual Equivalent Rate. It shows the yearly rate after taking compounding into account.

MER usually stands for Monthly Equivalent Rate. It may be used where interest is calculated monthly.

The important point is to compare rates on the same basis. Do not compare one product?s monthly rate with another product?s annual rate without understanding the difference.

Your adviser should explain the rate clearly and provide a personalised illustration showing the projected cost.

How does the loan balance grow over time?

The loan balance can grow if interest is rolled up and no repayments are made.

A personalised illustration should show how the balance could increase over time. It may include projected figures at future points, such as 5, 10, 15 or 20 years.

These figures are not a prediction of when the plan will end. They are there to help you understand the possible long-term cost.

The balance may grow faster if:

• you borrow more at the start
• the interest rate is higher
• you add fees to the loan
• you take further borrowing
• you make no repayments
• the plan runs for many years

The balance may grow more slowly if:

• you borrow less
• you use drawdown instead of a large lump sum
• you make voluntary repayments
• the interest rate is lower
• fewer fees are added to the loan

What happens if house prices rise or fall?

Your home?s future value affects how much equity may be left after the lifetime mortgage is repaid.

If house prices rise, there may be more equity available later, depending on how much the loan has grown.

If house prices fall or grow slowly, the loan could take up a larger share of the property value.

Modern lifetime mortgages that meet Equity Release Council standards usually include a no negative equity guarantee. This means you or your estate should not have to repay more than the property sells for, provided the plan terms are met and the property is sold for the best price reasonably obtainable.

However, the guarantee does not protect the inheritance value. It protects against owing more than the property sale proceeds. The equity left after repayment could still be much lower than expected.

Can equity release be cheaper than other options?

Sometimes, but not always.

Equity release may be suitable where other options are not affordable, available or appropriate. However, the long-term cost can be higher than other types of borrowing because the debt may last for life and interest can roll up.

Alternatives may include:

• downsizing
• using savings
• help from family
• a standard remortgage
• a retirement interest-only mortgage
• a later-life mortgage
• unsecured borrowing
• delaying the expense
• budgeting or debt advice
• checking benefit entitlement

The cheapest option is not always the best option, but equity release should only be recommended after suitable alternatives have been considered.

Read more here: Alternatives to Equity Release

Can you remortgage equity release later?

It may be possible to switch from one lifetime mortgage to another later, but this is not guaranteed.

You might consider this if:

• interest rates fall
• your current plan has limited flexibility
• you want to borrow more
• another plan offers better repayment options
• early repayment charges have ended or reduced

However, switching can involve costs, advice, legal work, valuation and possible early repayment charges. A new lender will also need to accept the property and your circumstances.

Remortgaging an equity release plan should be reviewed carefully. It may save money in some cases, but it may not be suitable in others.

How do costs affect inheritance?

The more interest that builds up, the less equity may be left in your property.

This can reduce the inheritance available to your family or beneficiaries.

The impact depends on:

• how much you borrow
• the interest rate
• how long the plan runs
• whether you make repayments
• future property value
• whether you take further advances
• whether you choose inheritance protection

Some products allow inheritance protection, which ring-fences a percentage of the property?s future value. This can help protect part of the estate, but it may reduce the amount you can borrow.

You can read more here: Equity Release and Inheritance

Can costs affect benefits?

The cost of the lifetime mortgage itself is not the only issue. The money released may affect entitlement to means-tested benefits.

If you release money and keep it in savings, it could affect benefits such as Pension Credit, Council Tax Support or help with care costs, depending on your circumstances.

This needs to be checked before proceeding.

Releasing money to pay for one purpose may have a different effect from keeping a large sum in your bank account. Your adviser should ask about benefits and may recommend specialist benefits guidance where needed.

Read more here: Equity Release and Benefits

Questions to ask about interest rates and costs

Before choosing a lifetime mortgage, ask:

• What interest rate applies?
• Is the rate fixed or capped?
• When does interest start?
• Is interest added monthly or annually?
• What will the balance look like in 5, 10, 15 or 20 years?
• What fees apply?
• Which fees are paid upfront?
• Which fees are added to the loan?
• Can I make voluntary repayments?
• How much can I repay without charge?
• Are there early repayment charges?
• How are early repayment charges calculated?
• Can I move home later?
• Is drawdown available?
• Will future drawdowns be at the same rate?
• Could this affect my benefits?
• How will this affect inheritance?
• What alternatives have been considered?

A suitable recommendation should answer these clearly and personally.