Individuals interested in putting their home to work can choose from one of several equity release strategies, which allows homeowners to use the money invested in their home to provide a steady source of income.
In this article, we're going to explain how homeowners can use an equity release strategy to create a future income stream. As part of that explanation, we're going to review several types of programs offered today. We'll also talk about the pros and cons of using this approach.
While the term "equity release" is used in this article to describe the return of a home's value back to its owner, the concept can be applied to any marketable asset. An equity release approach is similar to a reverse mortgage, although the cost of this arrangement is usually less. Unlike a home equity loan, the borrower isn't obligated to repay a portion of the outstanding principal each month.
While the number of equity release products is only limited by the imagination of marketers; in general, there are three different products in use today:
With all of these programs, the participant continues to live in the home until it's sold, which is one of the important advantages of these products.
A home reversion plan allows the homeowner to extract the exact amount of the home's value necessary to satisfy a need for income. The homeowner, as well as their partner, is permitted to stay in the house until it is sold. The amount paid in this plan is a function of the home's value, as well as the age of the participants.
When the home is eventually sold, a percentage of the sale's proceeds are paid back to the reversion company. This feature makes this type of plan inappropriate for individuals that want to leave the entire property to their heirs as part of an inheritance estate.
A Lifetime Mortgage plan allows the borrower to take out a loan that is secured by the home. With a lifetime mortgage, the loan itself, as well as the interest charges, are paid back when the home is sold; usually at the time of the homeowners' death, or when they move to a long-term care facility.
Since the principal and interest on the loan are not paid back, the accrued interest is added to the loan, and its size grows over time. When the home is eventually sold, the proceeds from the sale are used to pay off the loan's outstanding balance.
This final equity release product is called a shared appreciation arrangement. This plan allows the borrower to sell a percentage of the home to a lender. In doing so, the borrower agrees to give up a share of the home's appreciation in value. In exchange, the homeowner receives a lump sum payment from the lender.
For example, the lender might be willing to pay the homeowner 10% to 15% of the home's value in exchange for half (50%) of the appreciation in its value over time. If two people live in the home, the payment may be as high as 20% to 30% of the property's value; however, the entire appreciation (100%) in the home's value would be paid to the lender when it's sold.
These programs appear to offer retired individuals an ideal way of accessing the money they have invested in their homes. That's an excellent way of allowing some financially-strapped individuals to enjoy their retirement years. But as we'll soon explain, there are some disadvantages associated with these programs too.
This last point is an important one to understand. When an economic recession hits the stock market, home prices usually decline too. Retirees looking for alternative sources of income during these recessions might consider equity release to help close a financial gap. When home prices eventually rebound (as they historically do), the benefit of this rise in home value is shared with the lender.
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