Written by our independent equity release experts
Whenever you look at lifetime mortgage products online or speak with an equity release mortgage representative you hear the words interest rate. General interest rates are a percentage set up by the Bank of England to determine the cost of borrowing for the banks & this is then filtered down to other lending institutions. Depending on their profit margins over base rate & the financial risk profile of their lending product will determine its competitiveness in the market.
Financial companies like lifetime mortgage providers take the long term base rate set by the Bank of England to determine the cost of the loan that you will need to pay. It is generally set by a point system based on your credit history. The Bank of England base rate is currently set to 0.5% and you’ll currently see lifetime mortgage companies charging equity release interest rates of around 6%. However, equity release schemes look at interest rates over the longer term due to the potential life expectancy & term of the equity release mortgage.
There are three main points about interest rates that you need to remember:
• When the Bank of England base rate changes, the mortgage industry will change their rates. If the base rate increases, the mortgage rates will increase.
• The interest is a charge to you, but it is the return on investment for the bank. To loan you £100,000 without a charge would not be profitable, thus the Base Rate + additional charge.
• APR or annual percentage rate is how most interest rates are quoted. If the rate is 3% APR then it is divided into 12 months, where you pay a monthly interest rate on the principle balance. If the balance declines like a standard repayment mortgage, then the amount you pay interest on is declining over the years. In other words at the beginning of the loan you pay more to interest than to the principle balance than at the end of the loan term at least for standard mortgages.
Equity Release and Interest Rate Factors
Equity release products for retirees are normally set up to accrue interest each year, while the principle balance compounds. It is often called a roll-up lifetime mortgage scheme. At the end of the loan term, which is usually upon death or moving into long term care, based on the equity release interest rate & compounding effect the final balance could be double, even treble the capital sum based on 11 & 22 years. Most lifetime mortgages double every 10 to 12 years because the interest is compounding onto the original sum. Therefore, the lower the equity release interest rates the less compounding effect of the equity release scheme.
Imagine if the interest rate started out at 3%, but it was a variable rate. A variable rate can fluctuate. A fixed rate does not change and provides a degree of certainty of the future balance. If the rate can change and the Bank of England raises rates with the equity release provider increasing their rates to 5% then the loan becomes more expensive as time continues. One advantage to a variable rate is accessing a lower rate should interest rates fall, but the drop in rates may not be significant enough to cover the times it increased.
For equity release products it is imperative to have a fixed interest rate on the initial lump sum. There are also drawdown lifetime mortgage products, where the initial sum has a fixed interest rate that compounds onto the principle sum. There is also a reserve facility that a homeowner can withdraw more funds from. At the time of the withdrawal a new fixed rate is determined based on the Bank of England base rate. The second withdrawal still has a fixed rate, but the equity release interest rate can be different than the first capital and interest. It may be more or less. Ideally, a homeowner would like to see a lower interest rate, but this is why you must pay attention to the interest rates at the time you take out the loan as well as any additional funding later on.
Preferential Equity Release Interest Rates
The ideal solution is to have the lowest interest rate possible since this will equal less compounding interest. Even if you are making repayments it is still best to have the lowest possible rate attached to the principle amount. Interest repayments ensure the principle remains the same. However, you make a repayment of the APR based on a monthly calculation. In other words, the payment you make each month is based on the fixed equity release interest rate and a principle balance that never changes.
There are some equity release products that allow you to repay capital loan amounts as well as interest. If this is the case, you still want the lowest interest rate possible, but you are ensuring the principle declines along with keeping the interest paid and up to date versus products with compounding interest.
Interest rates are highly important to determining the future balance you will need to repay as well as the inheritance your beneficiaries receive, which makes it equally important to get the lowest rate possible to ensure your family is taken care of. Therefore, always seek independent equity release advice to find the right lifetime mortgage for you and your beneficiaries.
Typical Rates for Today
While examples have been used above, it is important to understand interest rates in 2015 are currently varying between approximately 5.13% to over 7.5% on equity releases. Even a fraction of a percent can have a significant impact over a long period of time, like your lifetime.
Legacy Equity Release Interest Rates
Historically, lifetime mortgage schemes have had relatively high interest rates. For example Aviva (formerly Norwich Union) had interest rates in their early days of over 8.5%. Therefore, with interest rates today being as low as 5.13% it could be prudent to consider switching equity release plans to save on interest & have a lower future balance. Remortgaging equity release schemes needs to consider many factors including set up costs and any potential early repayment charge. Therefore, speak to your local equity release adviser if you hold any of these legacy equity release schemes.