How interest works on equity release

Why interest matters more in equity release than most people realise

Interest on equity release works differently from a standard residential mortgage. Most lifetime mortgages allow you to make no monthly repayments at all, which means interest is added to the loan and compounds over time. Understanding how this works is essential before deciding whether to release equity.

• Interest usually compounds daily, though it is shown on an annual basis
• The balance grows faster in the later years of the loan
• Not making repayments means the amount owed can rise sharply
• Some modern plans give you repayment flexibility to help reduce costs

Why compound interest affects equity release so strongly

Compound interest means you pay interest on the original loan and on the interest that has already built up. According to Age UK, compound interest is a key reason the final loan amount can end up much higher than the amount borrowed, particularly if the plan runs for many years. This is why most advisers stress the importance of understanding the long-term effect before committing.

How daily compound interest builds up on a lifetime mortgage

Interest on lifetime mortgages is quoted annually, but the calculation usually happens daily. Even at modest rates, this can create a significant difference over time.

How lenders calculate interest

The annual interest rate is divided into a daily rate and applied to the outstanding balance each day. This means the amount you owe grows gradually but continuously.

This design is not unique to equity release, but it has a greater impact here because lifetime mortgages typically remain unpaid for many years. The Financial Conduct Authority highlights the importance of clear disclosure when interest compounding is involved, noting that consumers must be able to understand the long-term effect of interest when considering later-life borrowing.

What drives your total interest cost over the lifetime of the plan

• Your interest rate
• Whether you make voluntary repayments
• How long the loan runs
• How often interest compounds
• Future house price growth or decline

Why these factors matter

The interest rate is the single biggest driver of cost. A lower rate means slower balance growth. However, the length of time the loan runs is equally important. Lifetime mortgages do not have a fixed end date and are usually repaid only when you die or enter long-term care. This means a plan could run for decades, giving compound interest considerable time to accumulate.

ERC standards require all providers and advisers to explain these long-term effects clearly so customers can make informed decisions. They also require annual statements showing how interest is building, helping borrowers keep track of the loan over time.

How repayment options help reduce long-term interest costs

• Voluntary repayments on most ERC-standard plans
• Interest-only options to stop the balance growing
• Ad-hoc payments when financially convenient
• Downsizing protection on some plans to repay early without penalty

Why today’s plans are more flexible

Many modern equity release products let borrowers make voluntary repayments without penalty. These payments reduce the capital and slow the rate at which interest compounds. Some products allow interest-only repayments, which prevent the balance from increasing at all if maintained consistently.

The Equity Release Council emphasises the importance of flexibility, stating that product standards aim to give customers more control over their borrowing as their circumstances change. This shift in product design makes it easier for borrowers to manage long-term costs compared with older-style plans that offered no repayment options.

Understanding rolled-up interest and its effect on inheritance

• The longer the plan runs, the more interest builds up
• This reduces the value of your estate
• Beneficiaries may receive less than expected
• Some plans include inheritance protection features

Why this matters for estate planning

Equity release affects the amount you can leave behind. If you choose not to make repayments, interest will roll up and reduce the final value of the estate. Some lenders offer inheritance protection, which guarantees that a fixed percentage of the property’s value will be preserved, but this usually means releasing less upfront.

Age UK advises families to discuss equity release openly because of its impact on inheritance and long-term financial planning. They note that understanding the long-term cost is crucial before going ahead.

How to reduce interest costs over time

• Choose the lowest rate available
• Compare fixed and variable lifetime mortgage options
• Make regular voluntary repayments
• Review your plan periodically with an adviser
• Consider alternatives if your goal is managing long-term costs

Practical steps to lower your total cost

Getting the lowest possible interest rate makes a noticeable difference, but the biggest savings usually come from repayments. Even small, regular repayments can significantly cut the long-term cost by reducing the amount on which interest is calculated.

Reviewing your plan regularly with a qualified adviser can also help. If rates fall in future, you may be able to switch products, although early repayment charges may apply. The FCA encourages consumers to periodically assess whether existing borrowing remains suitable, especially in later life when needs and priorities may change.

When interest makes equity release unsuitable

Equity release is not right for everyone. If you want to protect as much inheritance as possible, or if rising long-term costs would cause concern, an alternative solution may be better.

Why suitability matters

The cost of compound interest remains the biggest drawback of equity release. While modern safeguards and flexible repayment options make plans safer, they do not eliminate the long-term financial impact. Suitability depends on your goals, income, other assets and how comfortable you are with the loan growing over time.

Professional advice from an ERC-member adviser is essential because they must explain whether a plan is appropriate and clearly outline its long-term cost, risks and alternatives.

Conclusion

Interest on equity release is powerful and can raise the total amount owed significantly over time. However, modern protections, repayment flexibility and clearer disclosure rules give borrowers more control than ever before. By understanding how compound interest works and taking steps to manage it, you can make a decision that supports your long-term financial goals and protects your estate as much as possible.