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Bird & Lovibond’s Guide to the pitfalls of equity release
At a time when retired people are struggling with low saving rates, debts or the spiralling cost of care, they are increasingly looking at equity release schemes to release value from their homes to raise extra cash. But this does carry potential pitfalls.
What Is Equity Release?
Equity release is a way for homeowners to raise extra cash in retirement. It is only available to those who own their home outright and are aged 55 or over.
You can receive a lump sum or take regular or occasional income and stay in your home until you die. However, your children and any other beneficiaries will receive less money when you die. This can make it popular with the elderly but less popular with their offspring.
We only recommend safe home income plans (SHIP) which is an organisation for financial firms whose plans meet certain standards which ensure the client is treated fairly. There are two types of equity release plan, a lifetime mortgage and a home reversion plan. The majority of people opt for a lifetime mortgage.
Issues to consider
Generally there are three things that make people wary of equity release:
- Their reluctance to reduce an inheritance left to loved ones
- Anxiety that it could be a risky or poor value or complicated transaction
- The concern that it may reduce entitlement to means tested benefits.
The first issue does cause real problems with families and it is imperative that you discuss your plans with your beneficiaries. It may be that they would be willing to advance the money to you rather than you relying on a financial institution.
There have been major problems with equity release in the past in particular with a product sold by Barclays and Bank of Scotland in the late 1990s. These “shared appreciation” mortgages were hugely popular to begin with, but borrowers did not realise how sharp increases in house prices would affect them. As a result many found themselves unable to move because they would lose a huge chunk of their property to the mortgage company. Often this was five or six times what they had originally borrowed. Banks no longer sell these types of mortgages.
Since 2004, the FSA has regulated all equity release providers and brokers so before dealing with anyone make sure they are on the FSA Register.
Lifetime mortgage, how does it work?
A Lifetime Mortgage allows you to borrow money from your property as a lump sum or take occasional or regular amounts.
The money is borrowed at a fixed rate for life. You never have to make any repayments during your lifetime.
Instead the money you borrowed is paid back from the proceeds of sale of your home usually when you die or go into care.
This sounds ideal, but it can be expensive way to borrow over a long term because the interest rolls up. Each month you pay interest on any interest already accrued as well as the balance. This is known as compound interest.
What you owe could double in 11 years which seriously erodes the equity in the property. For example if you borrowed £50,000, 11 years later at a rate of 7% the debt would be £100,000 and in another 11 years £200,000.
For this reason the younger you are, the less you will be able to borrow. A 65 year old would only be able to borrow up to 33% of their home. Whereas an 80 year old could borrow up to 48%.
What are the risks of a lifetime mortgage?
You really need to consider the impact of house prices and how that may affect any inheritance you wanted to pass on.
In the past property values have increased steeply. The average price has increased by 106% in the last 11 years according to Land Registry figures.
Many economists now believe prices will be flat and may even fall sharply over the next few years.
If they do increase you may build up some more equity to leave to your family even after the loan repayment has been taken into account. If they do not increase then your family must be prepared for the fact that they will have little or no inheritance.
This is why we only recommend a loan taken out through a SHIP registered company. These guarantee that the amount of loan repayable will never be more than the value of the house.
Remember also that releasing equity from your home may also hit your means tested benefits, as your savings can count towards these.
If you have a low income you may be able to claim pension credit.
Home reversion; how does it work?
For the home reversion plan you sell all or a percentage of your property in exchange for a lump sum.
For this reason they have been popular among those doing inheritance tax planning, as the size of your estate will effectively be reduced.
After getting your cash lump, you will be allowed to remain in your home rent free until you die, or you move into long term care.
However you will not receive the full market value of your property. What you get will vary depending on your age, the value of your property and your health.
The longer you are expected to live, the less you will receive. For example a healthy 65 year old male who owns a £150,000 home, if he sold the entire property to a home reversion company, he could expect to receive just 43% of the property’s value. This represents £64,500 lump sum.
If he chooses to release 50% of his property’s equity he would receive would be £32,250.
Upon death the house would be sold and the home reversion company would pocket half of the sale price with the beneficiaries getting the other half.
If a 65 year old couple live in the property they can expect to receive even lower market value, around 35%, or £52,000. This is because there is more chance of one of them living longer. The property is only sold on the death of the last partner.
The property is value by an independent surveyor who is chosen by the equity release provider. It may be worth getting a few other valuations from local estate agents to ensure that the surveyor is quoting a fair price.
What are the risks of home reversion plans?
Reversion plans have come in for much criticism in the past as they can result in families losing a huge stake in their home in exchange for very little cash.
Families do not like to discover that a company can take half of their parents’ property, which sells for £200,000 and that family is only paid £32,250 for their £100,000 stake.
Reversion plans used to be unregulated and as a result pushy salesmen were able to convince pensioners to give up large stakes of their property for tiny sums.
Today, reversion schemes are regulated by the city regulator and so companies have cleaned up their act.
Getting Advice
Clients must always take advice from an Independent Financial Adviser who specialises in equity release. Avoid salesmen who are just selling the product for one company.
Other Options
With savings rates low and pensions falling in value, older people will increasingly look to raise large lump sums to help fund their retirement.
If you need to raise cash, make sure you consider all your options. You could sell your home and move to somewhere smaller, but this is in itself a reasonably expensive option.
If you need money for a new boiler or to adapt your home for disabled living you may be able to get help from your energy company or a grant from your Local Authority.
Also, check you are receiving all the benefits to which you are entitled. Age UK will do a free “benefits check” at www.ageuk.org.uk.
Please contact Charles Shale, Simon Nash or Clinton Matthews-Stroud if you are thinking of applying for an Equity Release Mortgage.