How is interest calculated on Equity Release?

How is interest calculated on Equity Release?



  • 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 two illustrations below show the difference between an Equity Release Plan that has interest calculated and added annually and one that has interest calculated and added monthly.

  • 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

    Estimated fees charged during the year £

    What you owe at end of the year £

    1

    64 995.00

    1878.50

    Arrangement Fee 5.00

    66 878.50

    2

    66 878.50

    1932.79

    68 811.29

    3

    68 811.29

    1988.65

    70 799.93

    4

    70 799.93

    2046.12

    72 846.05

    5

    72 846.05

    2105.25

    74 951.30

    6

    74 951.30

    2166.09

    77 117.40

    7

    77 117.40

    228.69

    79 346.09

    8

    79 346.09

    2293.10

    81 639.19

    9

    81 639.19

    2369.37

    83 998.56

    10

    83 998.56

    2427.56

    86 426.12

    11

    86 426.12

    2497.71

    88 923.84

    12

    88 923.84

    2569.90

    91 493.74

    13

    91 493.74

    2644.17

    94 137.91

    14

    94 137.91

    2720.59

    96 858.49

    15

    96 858.49

    2799.21

    99 647.70

    16

    99 647.70

    2880.11

    102 537.81

    17

    102 537.81

    2963.34

    105 501.15

    18

    105 501.15

    3048.98

    108 550.13

    19

    108 550.13

    3137.10

    111 687.23

  • Roll up of interest added monthly:

    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 monthly.


    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 £

    Amount paid to you during the year £

    Interest charged at 2.89% £

    Estimated fees charged during the year £

    What you owe at the end of the year £

    1

    65000.00

    0.00

    1903.60

    0.00

    66 903.60

    2

    66 903.60

    0.00

    1959.33

    0.00

    68 862.93

    3

    68 862.93

    0.00

    2016.70

    0.00

    70 879.63

    4

    70 879.63

    0.00

    2075.77

    0.00

    72 955.40

    5

    72 955.40

    0.00

    2136.56

    0.00

    75 091.96

    6

    75 091.96

    0.00

    2199.14

    0.00

    77 291.10

    7

    77 291.10

    0.00

    2263.53

    0.00

    79 554.63

    8

    79 554.63

    0.00

    2329.84

    0.00

    81 884.47

    9

    81 884.47

    0.00

    2398.06

    0.00

    84 282.53

    10

    84 282.53

    0.00

    2468.28

    0.00

    86 750.81

    11

    86 750.81

    0.00

    2540.56

    0.00

    89 291.37

    12

    89 291.37

    0.00

    2614.97

    0.00

    91 906.34

    13

    91 906.34

    0.00

    2691.56

    0.00

    94 597.90

    14

    94 597.90

    0.00

    2770.38

    0.00

    97 368.28

    15

    97 368.28

    0.00

    2851.51

    0.00

    100 219.79

    16

    100 219.79

    0.00

    2935.01

    0.00

    103 154.80

    17

    103 154.80

    0.00

    3020.98

    0.00

    106 175.78

    18

    106 175.78

    0.00

    3109.45

    0.00

    109 285.23

    19

    109,285.23

    0.00

    3200.51

    0.00

    112 610.74


    As you can see, both providers are charging an interest rate of 2.89% yet, after 19 years, the provider that calculates and adds the interest on a monthly basis has an outstanding balance of nearly £1000 more.


    With a higher initial amount borrowed and/or a higher interest charged, then the differences will be proportionately larger. Some plans will allow you to make a regular payment 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.

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