How does compound interest work?
Unless you choose to make them, there are no repayments on a lifetime mortgage until the plan comes to an end. As a result, you pay interest not only on the loan, but also on the interest that’s already been added to the loan.
Whether interest is added to your lifetime mortgage monthly or annually depends on your plan. But during that first period, the interest is charged and added to the original loan amount - the sum of tax-free cash you unlock from your home’s value.
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Interest is then calculated and charged on what you owe (the original loan amount plus interest), not the amount you initially borrowed
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This new, larger amount of interest is then added to your loan, and this cycle continues until the plan comes to an end
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This means a larger amount of interest is added to your lifetime mortgage each period
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The interest rate at the beginning of your plan determines how quickly the interest grows which will impact the total cost of borrowing over the term of the loan
Here’s an example of how compound interest accrues over 15 years:
| Year |
Balance at start of year |
MER1 |
Interest added2 |
Balance at end of year3 |
| 1 |
£81,703 |
6.74% |
£5,681 |
£87,384 |
| 2 |
£87,384 |
6.74% |
£6,075 |
£93,459 |
| 3 |
£93,459 |
6.74% |
£6,497 |
£99,956 |
| 154 |
£209,360 |
6.74% |
£14,555 |
£223,915 |
This example is for illustrative purposes only and uses the average release amount of £81,703 and monthly equivalent rate of 6.74% – Key Market Monitor Q1, 2023.
1 With all lifetime mortgages, the interest rate is fixed throughout the life of the plan
2 Interest is charged on the balance as at the start of the year, not the original amount
3 The balance at the end of the year including compound interest
4 This cycle continues throughout the life of the plan
How can I reduce the cost of my lifetime mortgage?
There are ways you could reduce your total cost of the borrowing if, for example, you wanted to leave a bigger inheritance to your loved ones.
Making repayments
You have the option to make ad-hoc or regular repayments to help reduce your total cost of borrowing. Even if you can only make small repayments, it will help reduce the amount of interest you pay over the lifetime of your loan.
So, if you were to borrow £81,703, with a fixed 6.74% MER interest rate, and make no repayments at all, after 15 years, your total cost of borrowing would be £223,915. However, by making a monthly £250 repayment, after 15 years, you’d owe £146,440 - with a total cost of borrowing, including repayments, of £191,440. This means, by repaying £250 a month, you, and your beneficiaries, could benefit from a £32,475 net interest saving.
Remortgage to another equity release plan in the future
If interest rates reduce in the future, you may have the option to remortgage your current plan to secure a lower rate.
Consider a drawdown plan
With a drawdown lifetime mortgage, you only take out the money when you need it. This can help reduce your total cost of borrowing, as interest is only charged on the money you release, rather than the full amount available. More on lump sum vs drawdown.
What are the benefits and drawbacks of a lifetime mortgage?
If you're considering a lifetime mortgage, it's important you understand the product in detail. Here's some useful things to think about.
