How does a retirement interest-only mortgage compare with equity release?

If you’re over 55 and a homeowner, it would be comforting not to have to make monthly mortgage repayments and to gain access to the cash tied up in your home. With equity release or a retirement interest-only mortgage, these benefits are possible. But what are the differences between them and is one option better suited to your circumstances than the other? We’ll explain everything you need to know here to help you make the right choice.

What is a retirement interest-only mortgage?

This is a loan secured against your home and you only repay the interest on the loan each month. The capital isn’t repaid until your home is sold, which is usually when you go into long-term care or die.

Aimed at older borrowers, usually aged over 55, a retirement interest-only mortgage is beneficial as you have lower monthly repayments to make than with a standard mortgage. Generally, the amount you can borrow for an interest-only mortgage is lower than with a capital repayment mortgage but it’s a good option if you’re retired and have a regular income, such as a defined benefit pension. As you’re only repaying the interest, you only need to prove to the lender that you can afford the interest repayments rather than the loan amount.

If you currently have an interest-only mortgage but are unsure as to how you’re going to repay the capital when the mortgage term ends, switching to a retirement interest-only mortgage is a good idea.

What are the similarities with equity release?

Equity release is also aimed at older borrowers and lets you access the cash tied up in your home. You can remain living in your home until you either move into a permanent care home or die. The property is then sold to repay the loan. There are no monthly loan repayments to worry about and you only have to repay the interest if you choose a specific plan to accommodate this.

How is equity release different?

With equity release, instead of repaying the interest each month, it is usually compounded and repaid with the loan amount when the property is sold. As the interest is compounded over the years, which means you pay interest on the interest, the debt can grow very quickly.

This can significantly reduce any inheritance you may wish to pass on to your beneficiaries. You should ensure that you have a ‘no negative equity guarantee’ so that your estate doesn’t owe more than the proceeds of the sale. You can choose an equity release product that allows you to ring-fence some of your property’s value to safeguard it for your beneficiaries.

There are also different options available for equity release. Some allow you to repay the interest, such as an interest serviced lifetime mortgage.

The advantages and disadvantages of both options

Whatever your reasons for weighing up the two options, there are advantages and disadvantages to both, as detailed below.

A retirement interest-only mortgage

Advantages

• You can utilise some of the equity in your home. You can, for example, pay off any outstanding debts you have and live more comfortably during your retirement.
• It can prevent having to downsize to a smaller property. For example, selling your home in Bexley and moving to a smaller one in Bexleyheath.
• There are no monthly loan repayments to make, which gives you peace of mind when you’re on a limited income.
• This type of mortgage is usually cheaper than taking out a lifetime mortgage for equity release.
• There is no fixed term for this mortgage. Therefore, the capital isn’t repaid until the property is sold, usually when you go into long-term care or die.
• As you repay the interest each month, only the original loan amount has to be repaid at the end.
• You should have a larger inheritance to pass on to your beneficiaries than if you opt for equity release.

Disadvantages

• You need to prove to the lender that you can afford the interest repayments.
• If you fail to keep up with your monthly interest repayments, you risk your property being repossessed.
• You will have less to pass on to your beneficiaries than you would with a repayment mortgage.
• Your property has to be sold when you go into long-term care or die to repay the capital.

Equity release

Advantages

• You can access the equity in your home. You might want to do some home improvements, treat yourself to a luxury holiday or even buy a second property.
• You don’t make any monthly loan repayments.
• If you prefer, you can choose an equity release product that allows you to repay the interest.
• A drawdown option lets you receive smaller amounts at intervals rather than a single lump sum.
• You can continue living in your home without any restrictions.
• You can protect some of the value of your property for the sake of your beneficiaries.
• The loan isn’t repaid until you move into long-term care or die and your property is sold.

Disadvantages

• The compounded interest on top of the loan amount increases your debt very quickly. The amount to be repaid at the end is a lot higher than simply the loan amount due for a retirement interest-only mortgage.
• Equity release considerably reduces your property’s value and the amount of inheritance left to pass on to your beneficiaries.

Which arrangement is best for you?

With an outstanding mortgage to repay during your retirement, changing to a retirement interest-only mortgage removes the worry of having to repay the mortgage in full until such time as your property has to be sold.

If you have a secure income during your retirement, such as a defined benefit pension, a retirement interest-only mortgage is a good option as you repay the interest each month. If you don’t have a secure income or would rather not be tied to any monthly repayments, equity release is more suitable.

When you need a boost to your income – for example, if your pension isn’t sufficient to meet your living costs – equity release is a good solution. You usually receive a tax-free lump sum but options are available to receive smaller amounts as and when you need them.

With equity release, you can gift money to your children and grandchildren as an early inheritance. This is a good way to see your beneficiaries use their inheritance during your lifetime. For example, paying towards a wedding or the deposit for a house.

If you want to give financial help to a member of your family on a short-term basis, a retirement interest-only mortgage is possibly a better idea. You can release a small amount of cash from the equity built up in your home and the loan can be repaid after a short period. Check with the lender that this can be done under the terms of the mortgage.

As with any major financial decision, it’s imperative to speak with your financial adviser for professional guidance. Your personal situation and circumstances will determine which option is best for you.