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Compound interest explained

  • You pay interest on the loan plus the interest that’s already been added to the loan
  • You could make monthly repayments to manage your total cost of borrowing
  • Get your free comprehensive guide below

How does compound interest work?

Unless you choose to do so, there are no repayments to make on a lifetime mortgage until the plan comes to an end. As a result, you pay interest not only on the loan itself, but also on the interest that’s already been added to the loan. But there are ways you could reduce the total cost of borrowing of your lifetime mortgage which we outline in this guide. 

Whether interest is added to your lifetime mortgage on a monthly or annual basis is dependent 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. 

  • In the period following, interest is then calculated and charged on what you owe (the original loan amount plus interest), not the amount you initially borrowed
  • This new, larger amount of interest is then added to your loan, and this cycle continues until the plan comes to an end
  • This means a larger amount of interest is added to your lifetime mortgage each period
  • 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

An example of how compound interest accrues over 15 years

Product Balance at the start of the year MER¹ Interest added² Balance at the end of the year³
Year 1 £81,703 6.74% £5,681 £87,384
Year 2 £87,384 6.74% £6,075 £93,459
Year 3 £93,459 6.74% £6,497 £99,956
Year 15⁴ £209,360 6.74% £14,555 £223,915
Initial release amount of £81,703. Plan subject to a fixed interest rate of 6.74% MER (Monthly Equivalent Rate).
¹ With all Key lifetime mortgages, the interest rate is fixed throughout the life of the plan
² Interest is charged on 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?

All of Key’s lifetime mortgages come with features which could help to reduce the total cost of the borrowing if that’s important to you; for instance, if you wish to leave a larger inheritance to your loved ones.

Making repayments 

Even though there are typically no monthly repayments to make with a lifetime mortgage, all our plans come with the option to make ad-hoc or regular repayments to help reduce your total cost of borrowing. 

Even if you’re only able to make small repayments, it will help reduce the amount of interest you pay over the lifetime of your loan.

ⓘ Illustrative example

In this example, 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.

  • By paying a lower interest rate, you can reduce your total cost of borrowing. However, a reduction in interest rates in the future isn’t guaranteed.
  • It’s also important to remember that an early repayment charge (ERC) may be payable if you choose to remortgage your equity release plan. 
  • However, all our plans come with fixed ERCs, meaning they expire after a certain amount of time. Your Key equity release adviser can explain this in more detail to you.

Consider a drawdown plan

With a drawdown lifetime mortgage, you only take out the money you need 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 lifetime mortgage

How could a drawdown lifetime mortgage reduce my cost of borrowing?

As you only pay interest on the funds you release, you could potentially save thousands over the course of your plan with a drawdown lifetime mortgage. Here's an example to help you understand how this could work for you. 

ⓘ Illustrative example

This example is for illustrative purposes only and shows there are two customers who both have access to a lifetime mortgage facility of £81,703 at an interest rate of 6.74% (future drawdowns will be charged at the prevailing interest rate) - Key Market Monitor Q1, 2023.

Customer A

Customer A decides to take all their cash in one go through a lump sum lifetime mortgage, so interest is charged on the full release amount from day one.



(Orange bar)

Customer B

Customer B, meanwhile, takes an initial loan of £51,703 to meet their immediate requirements, so interest is only charged on this lower release amount. Customer B then decides to make two further £15,000 drawdowns over time, taking their total release amount to £81,703.

(Blue bar)

Customer B saves £32,851 in interest charges
While Customer B still borrows the same £81,703 over 15 years, because they take their money in stages, their total cost of borrowing is lower as interest is only charged when they release their funds. As a result, Customer B saves almost £32,851 in interest charges over the total life of their plan. This example is over 15 years but it could be longer or shorter.

Am I eligible for a lifetime mortgage?

If you're thinking about releasing equity from your home, it's important to find out if you could be eligible.

You can check this by using our free online calculator.

To take out a lifetime mortgage with Key, you must be a UK homeowner:

  • Aged 55+ (including all joint applicants)
  • With a property worth £70,000+

Back to "What's in this guide?"

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. 

Lifetime mortgage benefits

Your specialist equity release adviser will explain:

  • You can unlock cash from your home, tax-free, to help meet your needs in later life
  • You’ll always retain full ownership of your home and can stay in it for as long as you wish with a Key lifetime mortgage
  • You can choose to make reduced or no monthly repayments to suit your circumstances
  • You’ll never owe more than your home’s worth with a Key lifetime mortgage
  • You may be able to remortgage your plan in the future to release further funds or secure a better interest rate, although this isn’t guaranteed and may be subject to early repayment charges

Potential drawbacks

Your equity release adviser will also outline the following important things to think about:

  • A lifetime mortgage is a loan secured against your home and subject to compound interest, meaning the amount you owe can grow quickly
  • Equity release will reduce the value of your estate and may affect your entitlement to means-tested benefits
  • Equity release may leave you with limited or no property equity remaining
  • Equity release will reduce your financial options in the future
  • A lifetime mortgage is a long-term financial product and is not designed to be fully repaid until the death or entry into long-term care of the last remaining borrower, otherwise early repayment charges may apply

Equity release helps thousands of homeowners across the UK take control of their finances, so that they can live the later life that they deserve.

Explore how Key could help you put the life in later life.

Request your free, comprehensive guide today.

Why choose Key as your equity release adviser?

It's a regulatory requirement for anyone considering equity release to get specialist advice before taking out a lifetime mortgage. So why should you choose Key as your equity release company?

We're regulated experts

Key is regulated and a proud member of the Equity Release Council
 

Trusted award-winners

We've won 80+ awards and 17,000+ excellent Trustpilot reviews, making us the UK's most trusted equity-release specialist

BestEquityReleaseAdviser2022-(1).png

Highly experienced

We have over 25 years' experience in helping more than a million over-55s with tailored equity release advice on later-life products. Our knowledge means that, once we've taken the time to understand your needs, we’ll have a sound idea of what the right plan is for you.

Customer stories

 

ⓘ Did you know...

Over the years, more than a million customers have benefitted from our expert advice, experience and professionalism from Key. We've been rated 'Excellent' on Trustpilot and you can check out the great things our customers have to say about our equity release plans.

John's story

69, Retired

“I sat down with the adviser and he went through every single detail and concerns, plus a lot more which I didn’t know about. They took care of everything… it’s so uncomplicated… the process is so easy.”

Read more on John's experience

Watch more of our customer stories

Lifetime mortgage FAQs

When it comes to releasing equity from your home, we understand that you may have questions too. To help, we have compiled the answers to the questions we get asked the most. If you are still unable to find the information you're after, we are just a phone call away.

If you’re looking for ways to release funds from your home, you may be wondering “is equity release the same as a lifetime mortgage?” A lifetime mortgage is one of two types of equity release, allowing you to free up tax-free funds in later life. The other type of equity release is a home reversion, which Key don't offer.

The other type of equity release is a home reversion plan, which involves selling all or part of your home to a provider in exchange for a lump sum. We offer lifetime mortgages only, allowing you to keep full ownership of your home.

A key benefit of lifetime mortgages is that you retain full ownership and can continue living there for as long as you like.

A lifetime mortgage is a loan secured against your home. Usually, when you or the last remainng applicant pass away or move into long-term care, your home will be sold to repay the loan. Any remaining funds from the sale will be passed on to you or your nominated beneficiaries.

We're proud members of the Equity Release Council and provide lifetime mortgages that meet their standards, including the No Negative Equity Guarantee. This is an important protection which ensures you'll never owe more than the value of your home when your plan comes to an end.

This means there's no risk that you'll pass on debt accrued through equity release to your loved ones. In the unlikely event that your home decreases in value enough to leave a shortfall between the sale proceeds and the amount you owe, the no negative equity guarantee writes off the remainder of your loan.

If you currently receive or are eligible to claim means-tested benefits, taking out a lifetime mortgage may affect your eligibility as it will change your financial situation. Our advisers can review your current position and discuss your options moving forward including how a lifetime mortgage may affect any benefits you receive.

You may wish to repay some of your lifetime mortgage early and reduce the size of the loan you accrue interest on. Subject to criteria, we may be able to help you personalise your plan with the option of making ad-hoc repayments of up to 10%-12% of the initial amount you've borrowed each year.

Additional repayments, including repaying in full, may incur early repayment charges. Your adviser will explain these terms clearly so you know what your options are.

Things to consider 

  • All our equity release advice relates to Key lifetime mortgages only - a loan secured against your home
  • The loan, plus compound interest, is typically repaid through the sale of the property when the last remaining applicant passes away or moves into long-term care
  • Our fixed advice fee of £1,299 is only payable on completion

Read our equity release articles

Equity release isn't something you should rush into. Read our RetireWise articles to learn more about how it works and whether it's right for you.

How does equity release work?

 

How long does equity release take?

Is equity release safe?

Page last updated: Tuesday 06 February 2024