3.3.1 Equity release

In this video, Martin Upton and Jonquil Lowe discuss the growing market in equity release products. They examine the social and economic reasons for the growth in business and whether the products are a good way to raise funds for later life.

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MARTIN UPTON

Hello again. I'm here with Jonquil Lowe, who's a Lecturer in Personal Finance in the Open University's Economics Department. Jonquil has written widely on personal finance issues including equity release and it's about equity release that we're talking today.

Jonquil, equity release, a very fashionable product in the UK currently. What are the different types of equity release products?

JONQUIL LOWE

Okay Martin. There are two main types.

So there's a life time mortgage which basically you're taking out a loan against your home but you normally don't pay any interest during your lifetime so the interest is rolled up with the loan and paid off when you no longer need your home. And then the other type is called a home reversion scheme. Now that's a bit different because you actually sell your home or part of your home to a company that gives you a lump sum and you still retain the right to live in your home for as long as you need it and then when you don't the home is sold and part of the proceeds or even all of the proceeds then will go to the equity release company.

MARTIN UPTON

I've heard of a third product called 'sale and rent back'. Is that different from the other two?

JONQUIL LOWE

A 'sale and rent back' scheme, on the face of it, seems a bit like a home reversion scheme. So you sell your home for a cash sum but it's aimed at a completely different market of people. So it's aimed at people who are having money problems often in debt and selling their home is the only way they can see of getting out of those problems but unlike a home reversion scheme you don't have the right to stay in your home for as long as you need it. Typically you get a tenancy agreement that lasts five years. It may, or may not, be renewed after that and even during the five years the rent might be put up so it might be at a level that you can't afford.

So these are actually very different products. They're now very heavily regulated and since then fewer of them have been available but if you - if you're thinking about the sale and rent back scheme then go and get some professional debt advice first because there are probably better options for you.

MARTIN UPTON

Okay. Now not everybody can access equity release products can they? I mean, who can actually get such a product?

JONQUIL LOWE

Right. So they're aimed at people who own a large part of their home. They've either paid off their mortgages in full or the mortgage that's left is very small and schemes typically not available if you're under age 60. A few are available from age 55 but the most common age to take them out is between 65 and 74.

MARTIN UPTON

Right. Okay. Now what should you be taking into account if you're thinking about getting into an equity release product?

JONQUIL LOWE

Okay, well of the two types that I've mentioned home reversion schemes are not particularly popular at the moment. I think less than 1 per cent of equity release schemes -

MARTIN UPTON

Really?

JONQUIL LOWE

... yep, taken out are home reversion schemes. And I suspect that the reason for that is they work rather like annuities in the sense that you're selling part of your home now or even all of your home. You're getting a lump sum and the right to remain in your home so it's like living in your home rent free even though you've sold it and obviously the longer you live the better that deal is. If you were to die soon after taking out a scheme then you would have had a pretty poor deal basically. So I think in the same way that we've seen people not really liking to take out annuities because they tend to underestimate how long they might live. Draw down products in the same way have not really been particularly popular.

So we're looking mainly at lifetime mortgages and the thing about lifetime mortgages is with most of them they're roll up schemes, so the interest is being added and it's being added using compound interest so the interest's already added to the loan. You're then charged interest on not just the loan but the interest already added.

Now that means that the amount you owe can roll up very fast. At current interest rates the amount you owe would double in about twelve years. So it's very important to be aware that that's how they work, to discuss with your family that you've taken out one of these schemes because when the equity release loan is paid off there's going to be less to pass on to your children. And the financial ombudsman says that actually most of the complaints they get about these schemes are actually from families who didn't realise that their parents had taken out such a scheme and so have been a bit disappointed that their inheritance isn't what they had expected. But the other things to be very aware of are, if interest rates were to go up then the amount of interest you owe could start to rise very fast.

So it's really important to think about taking out a lifetime mortgage with a fixed interest rate so you know exactly how it's going to grow from the outset. And most of the lifetime mortgages available are at fixed rates. A few aren't but most are. And then the other thing to look for is what's called a 'no negative of equity guarantee', and that means that the loan will roll up and grow with the interest but never to more than the value of the home when it's sold.

MARTIN UPTON

That was the question I was going to come back to you with. The interest roll up and even if you're on a fixed interest deal, I mean and associate that with growing longevity, is it going to be a case that a lot of people that enter into equity release are simply going to blow the whole of the value of their property? And what happens then if they're still alive and in the house and what happens to the interest which adds to the bill again and then exceeds the value of the property? What happens in those circumstances?

JONQUIL LOWE

Okay. Well - well it won't, provided you take out a lifetime mortgage with this no negative of equity guarantee.

MARTIN UPTON

Right - okay.

JONQUIL LOWE

If you didn't then it becomes a debt against your estate. So you know when you've died your estate is everything you own less everything you owe and so whatever you owed on the lifetime mortgage would be deducted from the totality of your assets not simply the value of your home. But if the estate wasn't big enough to pay off everything then the remainder of the debt would die with you, you know there's not usually anyone else who would have to pick up the debts of the estate.

MARTIN UPTON

Okay. I mean difficult question. Do you think these products offer good value?

JONQUIL LOWE

Well yeah that's that is an interesting question. The lifetime mortgages the interest rates at the moment are about 1 and a half to 2 per cent higher than the standard variable rate …

MARTIN UPTON

On a conventional mortgage?

JONQUIL LOWE

... on a conventional mortgage. Which may make you think well that's a bad deal. But you have to think about the extra risks that the company is taking on.

So it's offering you a very long term fixed rate interest so regardless of what happens to interest rates in future and you know bear in mind in the past we've seen interest rates at very high levels you know, 11 per cent, 16 per cent, even higher. Whatever happens you're on that fixed rate. So the company's shouldering that risk and provided you've taken out a no negative of equity guarantee which is definitely, you know, to be recommended then the company's also taking on the risk that you might end up owing more than the house is worth and so the company makes a loss in the sense that it's loaned you money for longer than it ideally would have liked to have done given that in the last few years the amount it's lending you is no longer earning any interest.

So those are kind of the reasons why that interest rate is a bit higher than you would pay for a conventional mortgage and the gap used to be bigger. These schemes used to be more expensive but the market does seem to be becoming more competitive and that differential is narrowing so now it is only about 1 and a half, maybe 2 per cent more than on a conventional mortgage.

MARTIN UPTON

Given what you've told us, surely you shouldn't go anywhere near a product let alone sign up for one, without getting financial advice.

JONQUIL LOWE

Well and the regulator absolutely agrees. So in fact the regulations say you cannot take out a product, an equity release product, without getting advice. It doesn't mean you have to take the advice. You can ignore it but you must go through the advice process …

MARTIN UPTON

Go through the process …

JONQUIL LOWE

... and it's important to remember that we're not just talking about financial advice. Yes, that's very important, but you should also get advice from a solicitor and good schemes will insist that it's a solicitor of your choosing. And if you did take out a home reversion scheme where you actually sell your home you should also get an independent valuation of the home because obviously the valuation is very important.

MARTIN UPTON

It seems to me that if you are forced into the process of taking out equity release products or choose to take equity release products - let's not use the word forced - really that's your last roll of the dice when it comes to getting money for later life. Is that fair and are there other ways in which people who have got equity in their property, but maybe not much cash income, can actually improve things when it comes from them financially in later life

JONQUIL LOWE

Well it's an interesting question that because we do tend to separate out the home from all the other things that we accumulate during our lifetime and for obvious reasons because it's somewhere that we live. It's not just a store of wealth. Having said that a lot of people do plan ahead thinking okay yeah I'll save some through my pension but I've also got some wealth tied up in my home and that will help me in retirement as well. So it's not always a last resort decision to take out this kind of product. And people take them out for all sorts of reasons.

So the Equity Release Council which is the trade body for this area does regular surveys and about four in ten people say they take out these products to provide themselves with extra income but they also take it out to fund home improvements, to go on holiday, to help family members and that in particular since we've had what's called the mortgage review it's become much more difficult for people to get mortgages if they can't show that they can afford to pay off the mortgage and so you know we're seeing these products being used where people want to perhaps help their grandchildren to buy a house so they're helping them with the deposit and you know the affordability.

So there are lots of reasons for taking out these products and the alternatives to some extent depend on what your reasons are. So for example if you're paying for home improvements perhaps so that you can stay at home even though you've developed some you know mobility problems perhaps well a good first stop is to go to your local authority and ask whether there are any grants available to help you adapt your home because there well may be.

So maybe equity release isn't what you need you know. You can tap into some other resources. If you're looking for income well obviously you know check out first whether you're eligible for any state benefits perhaps you know pension credit. Have you checked that out first?

But another, you know, option you might want to consider is actually downsizing. You will always get better value for your home if you actually sold it and bought somewhere cheaper. But that's, you know, that's not a decision to be taken lightly either because particularly in older age you've got your established friends, you're near the health services that you know and so there may be very good reasons why you don't want to sell your current home. So there are other options.

And of course if you're at an earlier stage in life you know it's one thing to think well my home might provide some of the income or the lump sums that I might need later in life but it doesn't mean that you shouldn't look at saving through a pension and all those more conventional routes which are far more likely to help you be secure when you come to retire.

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There are essentially two types of equity release products.

Lifetime mortgages involve borrowing against the equity a homeowner holds on their property but without the need to make repayments. Interest on the borrowed funds is ‘rolled up’ with the original sum borrowed. On death, or the sale of the property, the lender recoups the initial sum borrowed and the rolled-up interest during the term of the loan. Lifetime mortgages can be taken out from the age of 55.

Home reversion plans involve the outright sale of a share in the property. So here the homeowner does not face interest being added on to the amount of money raised by the part-sale of their property. On the eventual disposal of the property, the lender takes the percentage share of the selling price agreed at the time that the home reversion plan was put in place. It is the share of the property value at the point of its sale that the lender recoups, rather than the sum paid for that share when the home reversion plan was put in place. Home reversion plans can only be taken out from the age of 65.

Equity release products are complex and have significant implications for families. No one should enter into such arrangements without seeking specialist financial advice and without discussing the matter with their families and other parties with an interest in the property involved.