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If you want to release equity from your home, how do you choose the right lifetime mortgage?

Releasing equity from your home is becoming really popular nowadays. Hordes of retired homeowners are cashing in on the value of their homes by unlocking capital through an equity-release scheme. In fact, equity release is increasingly seen as a way of plugging a gap in our finances to alleviate disappointing pension pots and rising levels of personal debt. However, equity release isn't right for everyone and should probably be seen as a last resort if your budget is stretched. If you want to find out why, read my previous article Why You Should Avoid Equity Release. But, if it's your the best option, what should you look out for? Let's look at the basics first. How do equity-release schemes work? Well, the first thing you need to know is that equity release is designed for older homeowners. To qualify for most plans you'll need to be at least 55 or 60 years old. Secondly, there are two distinct plan types: 'lifetime mortgages' and 'home reversion schemes'. What's the difference? A lifetime mortgage differs from a normal mortgage in one key respect: you don't have to make any payments to your mortgage lender while you are alive (unless you move out of your property into a care home). The flip side of this is that, because you are not gradually paying off your debt every month, interest rolls up quickly and can potentially swallow all the equity in your home. That's why it's vital to look out for a lifetime mortgage with a no negative equity guarantee, which means you'll never owe the provider more than your home is worth. You release part of the value of your home as a cash lump sum or, more unusually, an income. The debt must be paid in full when you die. Meanwhile, home reversion schemes allow you to sell all or a share of your property to a home-reversion company in exchange for a cash lump sum. When you die, your property is sold and the company receives whatever share they're entitled to. So if you sold them a 40% share, they would receive 40% of the proceeds from the sale. Unlike lifetime mortgages, home reversions are not a loan and no interest is payable. This means that you can leave a guaranteed inheritance to your heirs, if you choose to sell only a share of your property. Lifetime mortgages have a far greater market share so I'll focus on these first. I'll look at home reversions in more detail next week. What to look for in a lifetime mortgage Firstly, make sure the provider you choose is a member of Safe Home Income Plans (SHIP). Fortunately, most are, but not all. Members of SHIP always offer that vital 'no negative equity guarantee'. The table below shows the six best fixed-rate lifetime mortgages (schemes are also available with variable rates) currently available: The six top fixed-rate lifetime mortgagesProvider Scheme Int Rate Min/ Max Age Max LTV At Min Age Max LTV At Max Age Product Fee Stonehaven Lump Sum Lite 5.90% Fixed 55/ 75+ 12% 32% £595 Just Retirement Roll-Up Lifetime Mortgage 6.05% Fixed* 60/ 74+ 20% 40% ** £500 Bristol & West Mortgages Lifetime Mortgage 6.19% Fixed 60/ 85+ 20% 45% £595 New Life Mortgages Ltd Lifetime Fix 6.23% Fixed 55/ 90+ 15% 53% £595 National Counties BS Flexible Drawdown Lifetime Mortgage 6.27% Fixed 60/ 80+ 25% 40% £595 Mortgage Express Lifetime Mortgage 6.29% Fixed 60/ 90+ 18% 45% £599 Source: Moneyfacts 28/02/08. All providers are SHIP members. *Fixed rate age dependent. 66 to 70 yrs - 6.15%, 71 to 80 yrs - 6.25%, 80 yrs+ - 6.35%.**40% LTV at age 76+ for women and age 85+ for joint plans. The rate When deciding which plan to go for, you should also look at how the interest is calculated. Interest compounds monthly on most schemes, although a few - including Just Retirement - compound interest annually. Compounding interest year on year instead of month on month will reduce the total amount of debt interest that rolls up. The LTV Pay attention to the loan-to-value (LTV) limits which will tell you the maximum amount you could borrow as a percentage of the value of your home. In other words, if your home is worth £160,000 and you release £40,000, the LTV is 25%. Taking Stonehaven as an example, at age 55 you can borrow a maximum of just 12% LTV rising to 32% LTV at age 75 and over. The charges You'll also need to look at the charges. The table above shows the product fee for arranging the plan. But you may need to pay for a valuation on your home and your legal fees. Some providers, including Bristol & West and Mortgage Express, insist on charging you for their legal fees too. And look out for any miscellaneous costs - such admin or application fees - to make sure your plan isn't unduly expensive. Drawdown facilities Another important feature to look out for is a flexible drawdown facility. This allows you take further cash after your initial advance. Crucially this means you'll only have to pay interest on the amount you draw down and you shouldn't inadvertently borrow more than you need. Many borrowers unlock a large lump sum initially which is simply left in a savings account just in case it is needed in the future. But this really is a false economy because the amount of interest owed to the provider on this sum will far outweigh any interest earned in a savings account. It's far better to use a drawdown facility instead. The lifetime mortgage shown from National Counties is a good example. To start with you must take an advance of at least 50% of the overall agreed loan facility subject to a minimum of £10,000. The remaining reserve can be released at your request as ad-hoc lump sums (minimum £1,000) or as regular monthly amounts (minimum £200pm) or both. By using a drawdown facility, instead of taking a large lump sum in one go, your savings are kept down to a minimum. This means lower-income borrowers are less likely to jeopardise their eligibility for means-tested benefits, such as pension credits. But this feature doesn't come as standard.; for example, as the name suggests, Stonehaven's Lump Sum Lite provides a one-off cash lump sum only. Then again, this type of lump sum plan may be suitable if you have a good idea how much you need to borrow upfront. Before you make a decision please read all the terms and conditions, and make sure you understand exactly what's involved. Equity-release products can be pretty complex so be prepared to do some research. You might even consider appointing a specialist independent adviser to help you. Don't forget that once you sign up, you're locked in! And a final word of warning. Interest owed to the provider on a lifetime mortgage can roll up to such an extent that when the property is sold it's remaining value is completely wiped out. This is even more likely if you took the plan out at an earlier age, and it could mean there may be no inheritance to leave your family. For this reason it may be a good idea to discuss your plans with them first. > Read more: Will Your Home Be A Good Pension? > Compare mortgages through The Fool!