What is the Equity Release Compound Interest Formula?

Understanding the Equity Release Compound Interest Formula

Equity release can offer a flexible solution for many people to deal with their financial difficulties by accessing the equity built into their home; but it is important to remember that releasing equity from your home is a potentially life changing decision.

Depending on what type of equity release plan you opt for, you either lose ownership of a part, or all of your home, or have a lifelong mortgage secured on your property. Home equity schemes are not for the faint hearted and thorough research and professional advice is key to success.

In the case of roll-up equity release schemes, the interest on the lifetime mortgage keeps on compounding, and the final amount can often end up being so large as to erode all the equity in your home, leaving nothing for your beneficiaries.

Protection from ongoing compounding interest

However, the good news is that all equity release mortgages recommended by any authorised equity release adviser should come with ‘no negative equity guarantees‘. This ensures that the value of the equity release mortgage can never be more than the value of the property, period. This also provides protection for the plan-holders beneficiaries in that they themselves can never end up owing anything to the lender themselves.

In order to calculate whether this situation would ever arise you need access to an equity release compound interest calculator which can help you understand how much the interest on your mortgage could compound to over a certain term.

The viability of an equity release plan from the perspective of the lender, depends on what plan it is. For instance, in the case of an interest only lifetime mortgage, the shorter the term of the loan, the fewer the risks for the lender. But in the case of a roll up lifetime mortgage, the longer the term of the loan, the more interest compounds and the more profitable it becomes for the lender.

Equity release compound interestarises when the interest payable on the equity release loan amount is added to the loan amount itself, and interest is then payable on this combined figure, and so on and so forth. This way, the interest accrues interest on itself, and goes on compounding.

This compounding of equity release interest can quickly result in a large debt, and often this is the reason why many people with roll-up lifetime mortgages could have potentially been left with a negative equity on their loan. However, the no negative equity guarantee fortunately prevents this from ever arising.

Compound interest calculator tools

Without this it could have meant that far from being able to protect some of the equity in their home, they could have not only lost all the equity, but actually ended up owing money to the lender! An equity release compound interest calculator gives you a way to know exactly how much your loan balance will be every year. The calculator uses a simple formula to calculate the compounding interest on the loan amount and uses this to predict how much the amount will have grown to be after a certain period. This can help you plan ahead and get a better understanding of your finances and how much you’re likely to owe the lender after a certain number of years.

It is possible to set up a compound interest calculator on your own computer using software programmes such as MS Excel or Google Spread sheet. It is also possible to use an equity release compound interest calculator available on the internet.

Alternatively, if you would like more help with calculating the compound interest potentially payable on your mortgage, you can seek advice from an independent equity release adviser. They can always request a Key Facts Illustration from an equity release provider of your choice, where the year-on-year figures showing the compounding effect of the interest will be shown.