I have a confession to make. I have never been a fan of equity release mortgages. The reason why is because interest rates on such mortgages have always been too high for my liking. Let me explain why this has been my thinking to date.
Firstly equity release mortgages are interest only. This means that the mortgage can only rise in value. If the interest rate is, say, 7% then your mortgage will double in size over 10 years and quadruple over 20 years.
At the same time, your house value may not even keep pace with the interest rate in which case you have a problem. It is not inconceivable that your mortgage could become higher than your house price in which case you are in negative equity.
That is unless the equity release mortgage is through a member of the Equity Release Council which means that if you ever end up with negative equity the shortfall will be written off.
The question is, do you want your home to have little or no equity on your death meaning you have disinherited your loved ones from potentially one of the biggest assets in your estate when you pass away? Well of course the answer is no.
The good news is that in recent years the interest rates charged on equity release mortgages have reduced considerably. So much so that a typical equity release mortgage today carries an interest rate of about 3%. This is a game-changer.
The type of equity release mortgage I favour is a so-called lifetime mortgage. These mortgages are available for people aged 55 plus. I have even found a lifetime mortgage offer online quoting an interest-only rate of 2.7% for life with the interest rolled up. Whether such a great deal is actually achievable I do not know.
Borrowing money against your property may seem to be counter-intuitive if you are already retired or nearly retired and you do not actually need the money but hear me out as there is method in my madness.
If you are wealthy, married and you jointly own an expensive property worth say £1 million then you will have probably already used up all of your Inheritance Tax-free allowances between you consisting of both the Nil Rate Band (£325,000 each) and the Residence Nil Rate Band (£175,000 each) on death. That means that the rest of your taxable estate is subject to Inheritance Tax at a rate of 40% excluding Inheritance Tax (IHT) exempt assets such as pensions and other IHT free investments e.g. EIS and AIM ISAs (after 2 years of ownership).
In this scenario were you to borrow say £500,000 you could gift the money to your children or invest the money in IHT exempt investments. Not only would you save £200,000 Inheritance Tax from the mortgage debt (£500,000 x 40%) on your death but you would potentially escape IHT on the £500,000 re-invested after up to 2 years or, if gifted instead, after 7 years.
This strikes me as a win: win situation.
What are the possible disadvantages?
- Your investment may perform badly or fail
- You may fall out with your children and regret the gift you made
- There may be a high penalty if you decide to repay the mortgage early for example if you were to move house
- You may die prematurely and not achieve the Inheritance Tax savings you expected.
- You may regret having spent the money if you need care in later life.
So what type of person is likely to benefit the most from this sort of strategy? A sophisticated and/or high net worth individual who understands risk and has made an informed decision after carefully considering both the advantages and disadvantages.
I, for one, think it is a brilliant idea but it is definitely not right for most people. It is vital to take professional advice first before carefully weighing up the pros and cons. You know it makes sense.*
* This is a lifetime mortgage. To understand the features and risks, ask for a personalised illustration.
EIS and VCT investments are high risk. The value of an investment and the income from it could go down as well as up. The return is not guaranteed and you may get back less than you originally invested.
There are restrictions in relation to borrowing to invest in assets that will potentially qualify for business relief – see https://www.gov.uk/hmrc-internal-manuals/inheritance-tax-manual/ihtm28020
The contents of this blog are for information purposes only and do not constitute individual advice. You should always seek professional advice from a specialist. All information is based on our current understanding of taxation, legislation, regulations and case law in the current tax year. Any levels and bases of relief from taxation are subject to change. Tax treatment is based on individual circumstances and may be subject to change in the future. This blog is based on my own observations and opinions.