Second mortgage will not provide income

RELEASING the equity in your home by taking out a second mortgage is a way that many people can improve their monthly cash flow. But it is not a universally successful solution.

When Mr P was made redundant in 1987, his cash settlement amounted to just £42,500. Mr P had never worked anywhere but his old company and the strain of the redundancy caused him to have a breakdown. He was advised to invest his redundancy money in a managed bond, from which he could draw an income. Unfortunately, Mr P did not understand at the time that if the income he drew from his bond - about 8 per cent - exceeded the investment return, the capital would have to be drawn down to maintain that level of income. Today, at 55, and single, he has just £8,000 left from his original £42,500 (he encashed the bond when he realised what was happening to the capital) but he is still using some of the money to supplement his income as a freelance photographer. Last year he earned about £3,500 from this work.

"What I would like to know is whether there is any way of releasing equip in my house, in order to provide me with an income. I own it outright and it is valued at £115,000. I understand that there were Home Income Plans in Britain which can be repaid from the estate when the owner dies. I don't want to sell it as I expect my sister, who has no home, to move in when she returns here from Britain."

Home income plans have not been a success in Britain, mainly because the underwing loans were backed by stock market investments or managed funds which were unable to produce sufficient returns to meet the repayment costs. Many, mainly elderly, people lost their homes back in the late 1980s and early 1990s as a result of these badly designed schemes. Here attempts were made a few years ago to allow elderly people with relatively valuable properties to release a certain amount of its value in the form of an annuity, but at a seriously discounted rate. The participation rate was low and the scheme was abandoned.

Financial advisers we spoke with agreed that our reader has very limited options. Banks and building societies will let a person "release equity" in their property by taking out a second mortgage. Mr P would like to postpone repayment until he dies and the loan realised from the sale of his house, but the banks do not defer payment - instead they need to satisfy themselves that the borrower can repay the mortgage every month.

"It would probably be unsuitable for your reader to take out a mortgage at current interest rates to boost income," said one bank source, "since the deposit rate he would earn would be far less. He would be put at a disadvantage right away."

Two options are recommended instead: "Your reader could rent out some rooms in his house to generate additional income," suggests John Crowe of KPMG Stokes Kennedy Crowley's private clients division. The extra £200 or more a month would be tax free since it would still fall far short of the taxable income limits. He could also sell the house, say, buy a two bedroom apartment for himself and his sister and use any income from the balance of cash to boost his current cashflow. If he realised £40,000 he should be able to generate another £2,000-£2,500 a year or about £200 a month. But he should keep in mind that the selling and buying process will cost him as much as 10 per cent of the realisable value of the property."

Mr P should also think about selling his house and renting an apartment or house, said our bank source. A lump sum of about £110,000 would give him about £7,500 in annual deposit income at the best rates and boost his overall income to over £10,000. This isn't an inflation-proof solution, but his capital would remain relatively intact and available to him in his later years.