Compound interest on equity release. How does it work?
*Updated February 2024*
All equity release lifetime mortgages in the UK charge compound or 'rolled up' interest. The concept of compound interest is relatively simple, but in reality it can be confusing. If you’re considering a lifetime mortgage, it’s important to understand how compound interest works because it can greatly affect the amount repaid when the time comes.
How do you calculate compound interest on equity release?
Use our compound interest calculator to the total to be repaid on a lifetime mortgage, if you were to make no repayments at all. Simply enter the cash sum you'd like to borrow, the lifetime mortgage interest rate and the number of years you expect to have the loan for. To see details of current equity release interest rates visit our 'compare equity release interest rates' page.
In this article, I’ll explain what equity release compound interest is and how it works to help you make a more informed decision.
What is compound interest on equity release?
Compound interest on equity release refers to interest added either monthly or annually to the balance of a lifetime mortgage. Instead of only paying interest on the loan amount, you also pay it on the interest that’s already been added to the loan, so it grows at a much faster rate compared to simple interest. You can use our compound interest calculator below to get an understanding of the amount you may be required to pay back on a loan.
However, a benefit is that you don’t have to repay anything until you pass away or move permanently into care. At this point, the loan and the interest that has rolled up over the years must be repaid in full, usually from the proceeds of selling your home. This can be particularly attractive to homeowners seeking to reduce their outgoings and increase income in retirement.
How does compound interest on equity release work?
How compound interest on equity release works is probably best explained with an example.
If you take out a lifetime mortgage of £50,000 at a fixed rate of 6% per year and make no repayments at all, compound interest will roll up every year as follows:
Year 1 = £50,000 + £3,000 compound interest. Rolls up to £53,000.
Year 2 = £53,000 + £3,180 compound interest. Rolls up to £56,180.
Year 3 = £56,180 + £3,370 compound interest. Rolls up to £59,550.80.
Year 4 = £59,550.80 + £3,573.05 compound interest. And so on.
If you’d like another example of compound interest in action, take a look at our how much does equity release cost page.
How can you reduce the impact of compound interest?
You can reduce the impact of compound interest on your lifetime mortgage by choosing to make repayments on a regular or occasional basis. However, lenders will have different rules around early repayments and may impose limits on how much you can repay before incurring early repayment charges. Making voluntary repayments can help you chip away at the accruing compound interest.
Can you pay off the interest on a lifetime mortgage?
Some lifetime mortgages let you make voluntary repayments every month so you can pay off some, or all of the interest so it doesn’t roll up (compound) as quickly or at all.
A drawdown lifetime mortgage allows you to take cash from the loan as and when you need it, rather than taking it all at once. Compound interest is only added to the cash you take, which means it grows more slowly than it would on a lump sum lifetime mortgage.
Some lenders allow you to pay off up to 10% of the original loan amount, as an alternative to repaying any interest.
Can you get equity release without compound interest?
Technically you can get equity release without compound interest, by choosing a home reversion plan, however this is not a mortgage or a loan. Instead, you sell a percentage or 100% of your home to your plan provider for below market rate in return for a cash lump sum or regular payments.
Your provider then owns this percentage of your home and is entitled to this share when it’s sold, usually when you die or move into long-term care.
As the home reversion provider is effectively buying a percentage of the home no interest is charged and no repayments are needed.
Find out how much you could release
This article was written by Ashley Shepherd, Managing Director and founder of Simply Equity Release, the specialist later life planning website. With more than 30 years’ experience in financial services, Ashley is a recognised name in the equity release industry.
Learn more about Ashley.