Equity release vs RIOs – which is the best option for retirees?

Equity release and retirement interest-only mortgages (RIOs) are just two forms of lending for those who are approaching retirement. Both these options have their own distinct advantages and disadvantages, which are explained in more detail below.

The most common form of equity release is a lifetime mortgage. This is when someone takes out a loan against their property and repeatedly pays off just the interest rate until they die or move into long-term care. Once this happens their property is sold and the loan amount is repaid to the lender.

Generally, borrowers have flexibility in their interest payment when opting for this form of financing. You can either pay off your interest payments on a regular basis or you can miss your payments and let your interest accumulate. However, this does mean your interest payments will compound, and you could be left with a hefty fee in the future.

In accordance with the regulations set by the Equity Release Council, all equity release products are required to include a no negative equity guarantee. This means, in addition to not being at risk of repossession, you will never owe more than what your home is worth.

RIOs work similarly, as it is also a loan secured against your home. However, you will be required to make set monthly payments to your lender and, just like a residential mortgage, if you start defaulting your property could be repossessed. These monthly payments will typically just consist of the interest you owe, with the borrowed capital repaid upon moving to long-term care, death or selling your home.

While there are no age restrictions as with equity release, these types of products are typically aimed at older borrowers who may struggle to get a mortgage due to their age.

Those who have an interest-only mortgage, where you only pay off the interest on your mortgage on a regular basis and then your home’s capital repayment in one sum, could use equity release to pay off their mortgage. However, it is paramount that your home has enough equity to repay your mortgage. To find out more about this option read out guide Is using equity release to pay off an interest-only mortgage a good option? 

In some instances, those who are still repaying a capital repayment mortgage, which is more common, could use an RIO. In this scenario, it is important to see if you can keep up with the regular monthly interest charges because, if not, your home will be at risk of being repossessed. In addition, you will need to consider if there is a redemption fee on your current mortgage, and how that may affect your borrowing figure.

If these decisions already appear overwhelming it is best to seek the advice of an independent financial adviser.

Today, there are several equity release plans which allow borrowers to access their cash via drawdown. This can be one way to boost your regular income in retirement if you find that your current pension will not meet retirement living costs. However, be aware that your age will affect the amount you can borrow, with younger borrowers offered smaller amounts. That is why you should consider how much interest you could end up paying against your loan amount.  

If you are approaching retirement another option to consider is potentially purchasing an annuity instead.

One of the benefits of using equity release is that the cash is tax-free. This means that if you plan on gifting someone in the excess of £325,000 then equity release can bypass inheritance tax if certain criteria are met.

The main condition to look out for is if an equity release borrower dies within seven years of making the gift, then inheritance tax charges will apply. While we encourage all readers to seek further advice from a tax expert, like Kellands Hale, more information can be found through our guide How does equity release affect inheritance? 

Ultimately, negating the potential inheritance tax charges for your estate to pay back a continuous rate of interest on your equity release plan may be a risk worth taking for some borrowers.

Since RIOs have set regular interest repayments you never have to worry about compounding interest snowballing into a lump sum amount of debt, which will shrink your potential inheritance. Plus, because interest payments are fixed, then many RIO products tend to be cheaper than the average equity release policy.

RIOs also have the added benefit of allowing you to overpay, ultimately reducing the amount of debt you owe. Opting for such a plan, and ensuring you make the appropriate monthly repayments, means that there will be more of your estate to leave behind as an inheritance.

In March 2022, the Equity Release Council introduced the fifth product standard, which has a similar effect. The fifth product standard is a product feature which enables borrowers to make a penalty-free partial loan repayment, mitigating the effects of compound interest, and cut the cost of borrowing.

Before taking out either a RIO or equity release deal, a borrower should speak to an independent financial adviser who will be able to provide advice on the best options for their situation and circumstances.

Our preferred later life lending partner is Mortgage Advice Bureau, which can offer a comprehensive Equity Release Advice Service. This includes a personalised, full fact-find of each customer to gain an understanding of their financial situation.

Once completed, the review will explore alternatives to equity release to see if these might better meet the needs of the customer. If equity release is suitable, Mortgage Advice Bureau Later Life will make applicable recommendations to its customer.  

Click here to get in touch with MAB Later Life today.