Mining the cash in your home
Hefty house prices and the credit crunch have together created a rather unusual problem for many older people: they may be living in a lovely house worth several hundred thousand pounds, but their investments are shrinking and debts need to be repaid.
Every year, around 30,000 people who find themselves in this situation will opt to ease their financial problems by unlocking the value in their homes through a controversial process known as equity release.
It works like this: in exchange for cash – and being allowed to continue living in your house – you have to agree to sell all or part of your home to a specialist company, or take out a lifetime mortgage that’s secured on the property itself.
For some people this can be a very sensible move, giving them thousands of pounds to clear any debts, go on luxury holidays, buy a new car and generally improve their day-to-day standard of living. But for others, it may not be such a good idea, so you need to consider it carefully before opting to take this step.
Mining the cash
Equity release is generally only available for those aged 50 or over, and there are two main types: lifetime mortgages and home reversions. Under these umbrella terms come a number of varying themes and we’ll investigate each in turn.
So let’s take a closer look at all the options.
A lifetime mortgage is a loan that’s secured on your home, which means you can continue living in the property – although it will obviously have to be repaid, possibly from the proceeds of its sale when you die or, for example, move into a care home. Lifetime mortgages account for the majority of equity release plans sold and there are a number of different types. Most can be transferred if you decide to move house, although if you are moving to a property of lower value then you will usually have to repay part of the lifetime mortgage.
If you opt for a roll-up lifetime mortgage you receive a loan – in the form of either a regular income or a lump sum. Fixed or variable-rate interest is then added to the loan on either a monthly or an annual basis, although you do not pay the interest until your home is sold. However, the interest is charged on both the loan and the interest already accrued, which means the amount owed can grow quickly.
A drawdown roll-up mortgage, meanwhile, sees you taking smaller amounts over time, instead of a lump sum at the start. This means that the total amount that you owe will grow at a slower rate.
You could also go for an interest-only lifetime mortgage. In exchange for a cash lump sum, you pay interest on the loan each month at a fixed or variable rate. The amount you originally borrowed is repaid when your home is sold, although you have to be careful if you are on a variable rate as you may find it difficult to meet repayments should interest rates rise.
Another alternative is a fixed repayment lifetime mortgage where you receive a cash lump sum, but instead of being charged interest on the loan, you agree to pay the lender a higher sum than you borrowed when the property is eventually sold. How much higher the amount is will be agreed at the outset and is dependent upon your age and life expectancy.
You could also opt for a home income plan. The cash lump sum you receive is used to buy an annuity that gives you a regular income for life. Out of this income you will pay interest on your loan, often at an agreed fixed rate. The amount you originally borrowed is repaid when your home is sold.
Some lifetime mortgages include an agreement that the lender can have a share in any increase in the value of your home when it’s sold, in return for charging you a low rate – or, in some cases, no interest – on your loan. This is called a shared-appreciation mortgage.
A home reversion, meanwhile, is where you sell all or part of your home to a company. You get the sale proceeds either as income or a lump sum, or a mixture of both. Normally, you will receive less than the full market value of your house – usually between 35% and 60%. The older you are when you start the scheme, the higher the percentage you get, as statistically you have less time to live.
In addition, you will usually be allowed to carry on living in the home free of charge, while the company benefits from any rise in the property’s value. If you have only sold part of the property, you will also benefit from any rise in the value of the proportion of the property that you retain.
Home reversions, however, are less of a good deal when property prices are going down and the outlook for this market is questionable to say the least. Average values took a hit last year and 2009 isn’t expected to be much better.
Pros and cons
So could equity release be suitable for you? There may be plenty of product options available – and certainly no shortage of older people who could do with an injection of cash to help their day-to-day finances – but the fact is that equity release still doesn’t enjoy widespread popularity.
Despite the arguments in its favour, only a relatively small number of people go down this route, acknowledges Andrea Rozario, director general of Safe Home Income Plans (SHIP), the UK trade body for equity release providers.
“For many years it has been predicted that equity release will grow enormously in response to the gap in retirement funding,” she says. “However, while there has been growth, it has been modest compared to the underlying assets and to the financial needs and aspirations of a growing retired population.”
To illustrate her point, she cites the fact that of the estimated £841 billion of equity that has been built up by retired people, the amount actually released is only running at £1.2 billion a year. By anyone’s standards this is a very small percentage.
The total value of new business written during 2008 stood at £1,095.7 million – a 9% fall on the previously year’s figure of £1,210.4 million – while the number of policies sold dropped 4% from 29,293 to 28,224.
However, Rozario is not too worried about this drop. “A slight decline in business volumes in 2008 was to be expected given the turbulence in the economy over the past 12 months,” she says. “Overall, we are pleased with how the sector has held up.”
So why are people so reluctant? What’s buried in the equity release small print that puts people off? After all, it seems only sensible to release money that’s effectively stored in your house rather than taking out loans or running up credit card debts.
It’s also an industry regulated by the Financial Services Authority and complaints about the service received or products purchased can be channelled through the Financial Ombudsman Service (FOS).
Equity release can certainly benefit some people by releasing the value built up in their properties but it’s not the answer to everyone’s prayers, says Geoff Penrice, an independent financial adviser at Bates Investment Services.
“It should only ever be used as a last resort,” he says. “The negatives about equity release include the fact people can end up paying interest on top of interest which can greatly increase the debt over time and erode the capital that’s left for their families.”
Of course, there are other alternatives available to equity release, points out Andy Gadd, head of research at Lighthouse Group, and these should be explored in-depth before any action is taken.
“The main alternative is to trade down in property size to release capital,” he says. “It may also be possible that the home-owner is not claiming all of the state of local authority benefits and grants that they are entitled to.”
A lot of the problems with equity release stem from the poor reputation acquired a few years ago that it has struggled to shake off, according to Phil Spiers, chief executive of First Stop Advice and co-author of the book Care Options in Retirement.
The sky-high interest rates that used to be charged and the nightmare scenarios in which elderly people suddenly found they were plunged into negative equity are now, thankfully, in the past, but the perception still remains.
“It has received bad press in the past, but the industry has done a lot to clean up its act,” Spiers says. “Schemes are now charging fairer interest rates and guaranteeing that people won’t fall into negative equity.”
However, there are still issues to bear in mind. For example, most lenders would continue charging interest until your property was sold if you died soon after taking out a scheme. In particular, with a fixed repayment mortgage the higher fixed sum to be paid to the lender becomes due when you die which may well be expensive.
Turning over a new leaf
Having said that, the industry is now totally focused on promoting itself as a viable product, and issues such as the lack of consumer knowledge and government attitudes to retirement funding have recently been debated at the House of Lords.
An important part of this overall public relations campaign has been the setting up of the Equity Release Solicitors’ Alliance (ERSA), a group of established law firms specialising in equity release, which has committed to a charter guaranteeing it will provide the best legal advice to consumers undertaking such transactions.
Claire Barker, the group’s chairman, insists that equity release should be considered by older people in need of some extra money – despite the negative press that the industry has often attracted down the years.
“It is classed as a controversial area and a dark art by quite a lot of people, but we are here to educate consumers that equity release is a safe and regulated product,” she explains. “We want to raise awareness of it as an option in retirement.”
Whether the drive will be enough to turnaround these perceptions remains to be seen, but giving clients – and their families – a thorough grounding in the peculiarities of equity release can only be good.
Although the FOS receives relatively few complaints about equity release (43 new cases were reported in the past year, up from 34), those that do come in are often instigated by families of recently deceased relatives.
So what is the conclusion? Do these schemes really make sense in the current environment or should they be dismissed? It all depends on your individual circumstances, according to Spiers at First Stop Care Advice.
“Equity release provides an income while enabling you to stay in your own home for the rest of your life,” he says. “This may seem like the perfect solution for any pensioners struggling to make ends meet, particularly in winter.”
However, there are downsides that must be taken into account. “If circumstances change then older people might not have enough money remaining to fund alternative accommodation,” he adds. “Also, money received through equity release could seriously alter the amount of benefits or state support they are able to collect.”
How to ensure equity release works for you
* Research the market to see what’s available
* Discuss your situation with an independent financial adviser who specialises in this area
* Talk to your relatives and explain what you are planning to do
* Look around for the best available deals, asking what fees and charges will be applicable
* Ensure your preferred company is a member of Safe Home Income Plans, the trade body.
The circumstances in which a property is worth less than the outstanding mortgage debt secured on it. Although it traps householders in their properties, the Council of Mortgage Lenders (CML) says there is no causal link between negative equity and mortgage repayment problems. At the depth of the last housing market recession in 1993, the CML estimated 1.5 million UK households had negative equity but most homeowners sat tight, continued to pay their mortgages and eventually recovered their equity position.
A “traditional” mortgage, where the monthly repayments entail of repaying the capital amount borrowed as well as the accrued interest, so that during the loan period the capital debt is gradually paid off so by the end of the term the mortgage has been fully repaid. One advantage of a repayment mortgage is that it removes the risk of having a parallel investment (such as an endowment policy or pension), the performance of which is dependent on the stockmarket, such as with an interest-only mortgage.
An equity release scheme, where the money borrowed against equity in the property (up to a maximum of 50%) is subject to interest charges and although the borrower makes no payments during their lifetime, the monthly interest repayments will roll up and be added to the original debt, which will be settled on the borrower’s death. A lifetime mortgage is distinct from a home reversion scheme in that the lender never owns part of the property. But most lifetime mortgages are sold with a no negative equity guarantee. This means that if the loan is greater than the property’s value it’s a problem for the original lender and not the homeowner.
A term to describe financial products or ‘plans’ that help older homeowners turn some of the value (equity) of their homes into cash – a lump sum, regular extra income, or sometimes both – and still live in the home. There are two main types of equity release: lifetime mortgages and home reversion plans (see separate entries for both). Whichever type you choose, you borrow money against the value of your property, on which interest is charged, and the loan is repaid when the house is sold after your death.
Used by the holder to buy goods and services, credit cards also have a monthly or annual spending limit, which may be raised or lowered depending on the creditworthiness of the cardholder. But unlike charge cards, borrowers aren’t forced to pay the balance off in full every month and, as long as they make a stated minimum payment, can carry a balance from one month to the next, generating compound interest. As the issuing company is effectively giving you a short-term loan, most credit cards have variable and relatively high interest rates. Allowing the interest to compound for too long may result in dire financial straits.
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.
If you’ve have a complaint about a financial service product you have bought but the company you bought it from refuses to resolve your problem after eight weeks, the Ombudsman can help. The Ombudsman will investigate and resolve the matter. The Ombudsman is independent and its service is free to consumers. The Ombudsman may find in the company’s favour but consumers don’t have accept its decision and are always free to go to court instead. But if they do accept an Ombudsman’s decision, it is binding both on them and on the business.