Should you downsize or use equity release to tap cash from your home when you retire?

Nearly 700,000 people in the UK reached retirement age this year according to the Office for National Statistics, in what has been dubbed the ‘great retirement’.

Like most, they face a cornucopia of economic headwinds. The ongoing cost of living crisis, coupled with increased interest rates, inflation and energy bills have all put pressure on household finances.

Amid these conditions it is thought that two thirds of new retirees plan to keep working in some form, according to a study by financial services firm Abrdn.

For many, their home could also become a source of income either through downsizing to a smaller property and cashing the leftover funds from the sale, or through equity release mortgages.

Cost-cutting measure: A fifth of retirement-age Britons say they have considered downsizing in the current economic conditions

Equity release allows older homeowners to take out a loan of up to 60 per cent of the value of their home, which charges interest but does not need to be repaid until after they die or go into long-term care. 

Nearly one in five homeowners (17 per cent) said they had considered downsizing in order to save costs, according to Halifax.

House prices have risen dramatically over the past three years, fuelled by Government measures such as the stamp duty holiday which was aimed at keeping the property market afloat during the Covid-19 pandemic.

In March 2022 annual house price growth increased to 14.3 per cent, according to Nationwide’s house price index, the highest rate of growth since 2004.

It means that many will have seen the equity they have in their home increase substantially in a short space of time.

While this is good news for those wanting to use money tied up in their home to help fund retirement, many may be wondering how to make the most of that equity in a way that works for them. 

Both selling to downsize and equity release have pros and cons. We asked property experts about what the differences are, and how homeowners can decide which is the best option for them.

Is it worth downsizing to save money? 

The first thing to consider is how you use your home and whether it remains the right size for your lifestyle.

Is it too big and means you overpay in heating and maintenance costs? Or does the extra space mean you are able to host your family and friends, and supports hobbies such as gardening that may not be possible in a smaller property?

‘Emotional attachment can be huge and people can underestimate that,’ says Alice Watson, head of marketing communications at pensions and financial services firm Canada Life. 

‘Emotional versus practical is a tricky thing to get your head around. If you have a bigger family and want grandkids to stay for example, downsizing is really thinking about that emotional connection.’

There are other considerations that should be taken into account when considering downsizing. For example, are you an active part of the local community that you would lose if you chose to move away? Or are you close to amenities that would be harder to reach if you moved?

Equity release is always the last option a financial adviser will suggest, after exploring all of the other alternatives. This is because the interest rates can be prohibitive

Furthermore, finding the right smaller property may be more difficult than expected. Smaller homes are in low supply and high demand at the moment, with only 30 per cent of stock on the market having less than three bedrooms according to Zoopla.

The cost of moving may also be a factor in your decision. Stamp duty remains a significant barrier to downsizing, says Nick Mendes, mortgage technical manager at broker John Charcol.

On a £300,000 house you will pay £2,500 in stamp duty, but this rises dramatically to £7,500 for a £400,000 property.

And that is not the only sunk cost that comes with moving. 

‘Solicitor fees, moving costs – they are just a barrier to those who are potentially looking to downsize, especially when the equity is their pension and the costs will take a chunk out,’ says Mendes. 

Barclays estimates the average cost of moving in the UK is £11,777 – although in reality it may be significantly more or less depending on where you live and your property size.

However, there is no doubt that downsizing has its benefits.

‘My first comment would be definitely downsize [before considering equity release] – if it is right for you to do and you can find a property in your price bracket in your area,’ says Stuart Powell, managing director at Ocean Equity Release.

One of the key benefits of downsizing rather than equity release is that you have the capital straight away and, as Powell says, ‘you will earn interest rather than be charged interest’ on it.

‘Plus, there will be the potential to gift money to your family rather than waiting for you to pass away,’ he adds.

As well as getting a cash lump sum, living in a smaller home can also help to cut the cost of living in the long-term. 

Even with the Government’s energy price guarantee, which sees household energy prices being subsided so the typical household is expected to pay around £2,500 annually, the price of heating a home has risen significantly.

And from April 2023, while the guarantee will remain, the cap will go up – meaning that the average household will now pay just over £3,000 a year for their energy for the following 12 months.

Reducing the size of your home will cut your gas and electricity costs. For a two-bed house, financial advice website Unbiased estimates the average annual energy bill is £850.01. For a four-bed this jumps to as high as £2,292.

In addition, upkeep of a smaller property  is often cheaper and easier, and the council tax bill may reduce if you drop down to another band or move to an area which charges less. 

‘We know older people traditionally spend more on heating,’ says Chris Sykes, technical director at mortgage firm Private Finance.

‘Sometimes big old houses that don’t have good energy efficiency, and maybe they don’t have the cash to make the necessary improvements to lower their bills. And now they are looking at energy costs in the thousands per year.’

Higher bills, say experts, are a big motivator when it comes to downsizing.  

‘People don’t want to lose their homes, but something has got to give,’ adds Mendes. 

Equity release rates have shot up over the past year but could still be the right option for you

When should you consider equity release? 

The obvious benefit of equity release is that you get to stay in your home.

Equity release loans allow homeowners over the age of 55 to access the value that has built up in their home tax-free.

The most popular type of equity release plan is a lifetime mortgage. This is where the property owner takes out a loan secured against their home which is worth up to 50 per cent of its value. Crucially, they remain the sole owner.

>> Request a free guide to equity release 

You are, of course, charged interest on the loan against your home. The rates are higher than a traditional mortgage, and unpaid interest compounds over the period of the loan.

There are ways to reduce the interest burden, for those that have the money to make optional regular repayments. 

Traditionally interest was only repayable on death or sale of the property, but product developments mean you can now access deals that allow you to pay off the interest incrementally. Borrowers also now have the right to make penalty-free partial repayments of their loans.

There have also been changes tht allow inter-generational wealth planning, so part of the property equity can be ring fenced for inheritance ensuring that there is something to pass on to loved ones. Likewise, you can opt for an equity release facility whereby you only draw down a proportion of the loan initially and then the rest later on. 

But the price of equity release deals have shot up over the past year. In December 2021 the average rate across all products was 4.2 per cent, but this month the average is 7.16 per cent – a 2.96 percentage point increase over the year, according to Moneyfacts.

The current average is now below the peaks seen over the past eight weeks following the sharp rise in borrowing costs in the wake of the mini-Budget, however. In November the average rate for equity release loans was 8.13 per cent. 

While it may work well for some, anyone considering equity release is urged to consider the implications carefully and explore all other available options first. 

Alice Watson warns that equity release products are usually the very last option on a financial adviser’s list as an additional source of income.

‘Equity release is not a short term decision,’ she says. ‘If it’s just cost of living concerns then there are better ways to finance it.’

They will take a look at any investments, savings accounts or other assets, and assess other options such as renting out a room. The objective is to make sure all other avenues have been exhausted before turning to a lifetime mortgage product.

It is also important to remember that an equity release mortgage will probably be with you until the end of your life – a period that could far outlast the current cost of living pressures.

This post first appeared on Dailymail.co.uk