Rising house prices has resulted in some older homeowners unlocking the equity they have built up within their own property to gift house deposits to their children via equity release, but for those with children who already own their own home, is it is good idea to take equity release to pay off their mortgage?
A key benefit to parents gifting their children their inheritance early to pay off their mortgage early is that it will likely free up a substantial chunk of their monthly outgoings and the money can be used towards creating a more financially secure future instead, for example by increasing their pension savings or investing.
In fact, recent research by equity release advisors Key found that 1.7 million inheritors used the money to pay off their mortgage. Although Key revealed that the average age people inherit is 47, it also found that 29% of those receiving an inheritance do not do some until they are aged 65 to 74; by which most homeowners have repaid their mortgage.
As such, many parents might be tempted to gift their children their inheritance early so that it cannot only help towards their children’s future, but will also enable them to see their children benefit from the money. As Will Hale, CEO at Key, explained: “The idea of inheritance arguably works best when the person receives the support at a time in their life when it can do the most good for their long-term financial security. However, with the average age of inheritance sitting at 47 years old – when people are more likely to have built up assets – we are seeing more conversations happening about providing people with a ‘pre-inheritance’.
For many people their most valuable asset is their home, resulting in it likely being the bulk of the inheritance they leave behind. This means that for many homeowners wanting to gift their children their inheritance early they will have to unlock the equity they have built up in their homes. One of the most popular ways to do this is by taking out equity release.
Equity release allows homeowners to unlock the wealth they own in their homes through a loan, the size of which depends on a number of factors including the value of the property, the amount of equity the homeowner owns in their home and amount the homeowner wants to borrow. The equity release loan does not need to be repaid during the borrower’s lifetime, unless they move into permanent care, but is repaid by the sale of the property after their death. Along with repaying the amount borrowed, the sale of the property also has to cover interest that has accumulated on the equity release loan, which can significantly impact the amount of money that is left after the equity release loan is repaid – although a negative equity clause means that inheritors will never be left with additional equity release debt after the sale of the property, even if the sale does not cover the full amount including interest.
Due to the long-term impact equity release can have on finances it is important for those considering equity release to seek independent financial advice first to ensure it is the right option for them.
In recent years average equity release rates have been falling helping to reduce the interest accumulating on money borrowed via equity release. Over the last six months, however, mortgage rates have also fallen, resulting in some high street lenders now offering record low sub-1% remortgage rates. As a result, those considering taking equity release to pay off a mortgage may want to carefully consider whether the interest that will be added to an equity release loan is worthwhile compared to the interest being paid on a fixed rate mortgage deal.
When considering taking equity release to pass on inheritance early it is important to keep in mind that the money gifted may be subject to inheritance tax. Currently, money can be gifted and will be exempt from inheritance tax if the person giving the money lives for seven years or more. If, however, they die within the seven years the money gifted will form part of the deceased person’s estate and will be liable to inheritance tax as a result. As Jennifer Skehan, chartered financial Planner at Kellands, explained: “If you use equity release to reduce or repay a child’s mortgage, there could well be inheritance tax implications. You can use the £3,000 per annum gift allowance but if your gift exceeds this and you die within seven years, the gift you gave your child for their mortgage could be subject to inheritance tax. It’s always best to take specialist advice on estate planning and inheritance tax planning, as the rules and potential options and solutions are complex so specialist advice in this area is always the best solution – in the meantime, further information on how inheritance works can be found on the government website. https://www.gov.uk/inheritance-tax.”
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Although equity release can be a good way of passing on inheritance early, those wanting to gift money to their children to repay their mortgage may also want to consider alternative options. Downsizing to a smaller, cheaper home, for example may be a good option for those who do not want to take equity release but who still want to release wealth they have built up in their current home. Alternatively, those with assets and investments, such as a buy-to-let property or stocks and shares, may want to consider using these instead. Another option, depending on how much has been saved into a pension pot, is to use money taken from pension drawdown or their tax-free cash lump sum. All these options, however, will have an impact on future finances and some may result in running out of money in old age, as well as having tax implications, so it is worthwhile speaking to an independent financial advisor to discuss all possible options and the impact they can have on future finances.
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