What you need to know about how interest is calculated on an Equity Release plan
The amount you owe on an Equity Release Plan is most commonly calculated by “rolling up” the interest.
If you have ever used a savings account you will already be familiar with the principle of “rolling up” interest, although you may be more familiar with the term “compound interest” when it comes to describing your own savings.
In short, the starting point is the cash you have taken from your Equity Release Plan. This may include any administrative costs that have been agreed to be added to the amount borrowed.
This initial figure is sometimes called the “Principal Amount”
The way “roll up” of interest works is that interest is calculated on this initial amount and added to it. Then, interest is calculated on this new total and added to that. This is repeated for each interest charging period throughout the lifetime of the Equity Release Plan.
The most obvious feature of rolling up the interest in this way is that interest will be calculated and charged including the addition interest.
This means that the total amount that you owe will grow at an accelerating rate with each charging period adding more in interest charges to the outstanding loan than the previous one.
The interest rate is fixed so any illustration you are given showing how much you will owe at any given time in the future can be relied upon as being accurate.
The charging period used by Equity Release providers can either be monthly or annually. This means that two different providers which appear to be charging the same interest rate will show different amounts being owed after exactly the same periods of time. The majority tend to use annual charging periods, the table below shows how that works. When researching between lenders it is important to look at the total amount of the outstanding balance for the same time period. That will indicate which is the better value based solely on the interest rate charged.
Roll up of interest added annually:
This shows how the amount paid to you, the interest, and any fees that may be charge mount up over 19 years. Its has been calculated using the illustrative interest rate of 2.89%. Interest is added to the amount you owe annually.
Remember, the mortgage could run for a longer or shorter time than 19 years, and if it runs longer, the amount you owe, will carry on increasing.
| Year | Balance at start of year £ | Interest charged at 6.24% £ | Estimated fees charged during the year £ | What you owe at the end of the year £ |
|---|---|---|---|---|
| 1 | 50,000.00 | 3,204.01 | 0.00 | 53,204.01 |
| 2 | 53,204.01 | 3,414.12 | 0.00 | 56,618.13 |
| 3 | 56,618.13 | 3,635.78 | 0.00 | 60,253.91 |
| 4 | 60,253.91 | 3,869.26 | 0.00 | 64,123.17 |
| 5 | 64,123.17 | 4,120.66 | 0.00 | 68,243.83 |
| 6 | 68,243.83 | 4,379.24 | 0.00 | 72,623.07 |
| 7 | 72,623.07 | 4,663.54 | 0.00 | 77,286.61 |
| 8 | 77,286.61 | 4,963.03 | 0.00 | 82,249.64 |
| 9 | 82,249.64 | 5,285.46 | 0.00 | 87,535.10 |
| 10 | 87,535.10 | 5,617.16 | 0.00 | 93,152.26 |
| 11 | 93,152.26 | 5,981.86 | 0.00 | 99,134.12 |
| 12 | 99,134.12 | 6,365.98 | 0.00 | 105,500.10 |
| 13 | 105,500.10 | 6,779.58 | 0.00 | 112,279.68 |
| 14 | 112,279.68 | 7,205.01 | 0.00 | 119,484.69 |
| 15 | 119,484.69 | 7,672.82 | 0.00 | 127,157.51 |
| 16 | 127,157.81 | 8,165.52 | 0.00 | 135,323,03 |
| 17 | 135,323.03 | 8,696.02 | 0.00 | 144,104.05 |
The £85 in the final year is a typical admin fee that is charged when the account is eventually closed and repaid. This table is solely to be viewed as an example.
With a higher initial amount borrowed and/or a higher interest charged, then the differences will be proportionately larger. Lifetime Mortgage plans will allow you to make regular or irregular payments into your plan in order to reduce the amount of interest charged. If you choose this option, then you will be given an illustration that will take this into account.
There are many factors you need to consider before deciding to proceed with an Equity Release Plan, the interest rate and how it is calculated just being two of them.
It is unlikely that you will choose an Equity Release provider solely on the interest rate being charged either monthly or annually, but it is important that you are aware of the differences between these methods of calculation and you should discuss it with your professional advisor.
