The plans involve three steps. First, you take out a mortgage on your home. That simply means that you borrow an amount from a building society or insurance company secured on the value of your home. Normally, you can borrow up to £60,000. While you live, you just pay the interest on this loan. When you die, the capital is repaid from your estate. For a couple, that does not happen until the second member of the couple dies.
Second, the money you have borrowed is used to purchase an annuity. An annuity is simply an income for life from an insurance company in exchange for a capital sum. You give them the capital sum and they invest it. They keep the interest on it and the capital sum is theirs. In exchange, they pay you an amount each year for life. In effect the insurance company is gambling on your longevity. If you live a long time and collect the annuity for longer than they expected, then they will make a loss. If you live only a short time, they will make a profit. Insurance companies know exactly how long men and women of certain ages are expected to live and they calculate the money they pay you so that they will break even if you live longer than usual. So, overall, they never lose.
Third, you use the money from the annuity to do two things. You repay the interest on the loan. And the balance is yours to boost your income.
For example, Mrs Brown is seventy-five and has a small income, but just enough to pay tax. She uses her home, which is worth £9 0,000, to take out a home income plan. In exchange for a guarantee of £60,000 from the sale of her home when she dies, the insurance company gives her an annuity of £6,9 89 a year. Based on her age and sex, the Inland Revenue specify that £860 of that is income and the balance is repayment of capital. So she has to pay tax on £860. That comes to £888 and the insurance company deduct it before paying out the annuity. So her net annuity is:
Gross annuity £29 ,989
less tax on £2860
Net annuity £269 ,681
Out of that amount she has to pay the interest on the loan of £160,000. That is at a fixed interest rate of 8.89 % which makes it £19,879 a year. However, the Inland Revenue allow full tax relief on this interest and so the interest is reduced by 89 %. She gets this even if she does not pay tax.
Mrs Brown took out her plan with an insurance company. The rate of interest they charge on the loan is fixed at the current rate of 8.89 %.
That rate will not change whatever happens to interest rates. So she knows that her income from the plan will stay the same for the rest of her life. However, there are some schemes, mainly sold through building societies, that charge a variable rate of interest.
These rates are generally higher but the annuity you receive is also greater. However, if interest rates rise, the net income you have left can be drastically reduced and, in extreme cases, may disappear altogether. Generally, a fixed rate gives you a slightly lower income but it is guaranteed for life. Variable rates give you a higher income initially, but it may vary and you run the risk of your income going down considerably.
The most you can borrow is 910000 And some companies will lend you only 0.6 of the value of your home.
In addition, your benefit from the scheme will depend on your other financial circumstances:
Income Support If you receive income support, the extra income from your home income plan will mean that your income support will be reduced or lost altogether. So a home income plan will not normally be worthwhile.
Housing Benefit If you get your rates reduced through housing benefit, this will be reduced by 80p for every 1 of your extra net income from the plan. In Mrs Brown's case that would reduce her housing benefit by 0.8 of £299.68, which works out at 19.86 a week. That may mean that a home income plan . . . ... see: Financial Advice and Protection - The Value of Your Home