The rise of equity release
A rising number of people are turning to equity release, to free up property wealth in retirement without having to leave their homes.
Key Retirement, one of the biggest equity release lenders recently estimated the market is growing at 24% a year, with £934 million accessed through equity release schemes in the first half of 2016. The average borrower took £76,300 cash.
And in June, Legal & General announced equity release sales surpassed annuities for the first time. That’s partly down to the rise of equity release, but it’s also down to people choosing to take advantage of the new pension freedoms to cash out pensions or use drawdown instead of buying an annuity.
Many people in the UK don’t save and invest enough, but instead rely on rising property to fund their retirement. Research published today by Aviva claims 69% of over 45 year olds say their home is worth more than their pensions, savings and investments combined.
According to Nigel Waterford, chair of the equity release council, this is a catalyst for the equity release sector. He says: “Rising demand for using property wealth in retirement is driven by a number of factors, including paying off mortgages, funding home improvements or adaptations for later life, and helping younger family members to get on the property ladder.
“While unlocking housing wealth via equity release will not be the right solution for everybody, it should be on everyone’s checklist when planning for retirement. Importantly, it can help them achieve the goal of remaining in their homes for as long as possible, with their right to do so not depending on deducting regular repayments from their retirement income.”
However, former pensions minister Steve Webb says relying solely on property for retirement could be a recipe for disaster: “In most of Britain, the amount of money you could free up by trading down at retirement to a smaller property would generate a very modest income,” and the same is true for people planning to fund a long retirement through equity release.
He adds: “Someone who chose to save for later life through their home rather than through a pension could easily see their income halve at retirement. If they opt out of workplace pension saving they are also missing out on tax relief on pension contributions and a valuable contribution from their employer.”
Banks getting in on the act
Banks are taking an interest in the rising popularity of equity release– Santander recently announced a five year partnership with Legal & General to offer drawdown products to its existing customers. Some of these people will be entering retirement and looking for cash.
Another group of people who might turn to equity release are those with maturing interest-only mortgages. When these loans mature, borrowers need to find the cash to repay the loan in full, and equity release can be a useful option for people facing a shortfall.
As part of Santander’s partnership with Legal & General, Santander will offer free advice to people around equity release – either for cash in retirement, or to plug the gap on an interest-only loan.
Equity release products are complicated, and need to be completed by a financial adviser. Though free advice from Santander might sound good, these advisers won’t consider every equity release option, and better deals might be found by a financial adviser.
How expensive is equity release?
Critics say equity release loans are very expensive for a couple reasons.
The first is that interest rates are generally higher than on standard mortgages. This is because borrowers don’t repay anything until the loan matures, meaning lenders don’t see any returns for longer.
What’s more, reputable equity release products have some extra consumer protections, which add to lenders costs. These include a guarantee that borrowers will never end up owning more than the value of their property, which can put lenders at risk of falling house prices, so rates need to be higher to accommodate this risk.
The second reason equity release loans are more expensive is deferring repayments mean compound interest works against the borrower. If you borrow £10,000 at 5%, you’ll owe £10,500 after a year. In the second year, that 5% interest is also charged on the first year’s interest – so the outstanding debt can snowball.
At rates of 4.5%, a £50,000 equity release loan will grow to £100,000 debt in just over 15 years. That is quite expensive, but the terms do offer substantial benefits over traditional mortgage, loan or credit card, namely there’s no need to make monthly payments, and a guarantee on the maximum the borrower will need to repay.
What protections should equity release borrowers look for?
Equity release is only available through financial advisers, which might be paid for by the borrower, or the mortgage company. If the mortgage company is paying, borrowers should be aware that not every possible product will be considered.
Equity release products come in two types. The first are called ‘roll ups’, where the homeowner borrows a set amount of money, which rises as interest is charged each year. Some of these products let people take some of the money up front, and some later, which will cut down the interest they pay overall.
The second type, home reversion policies, allow homeowners to sell an equity stake in their homes, though if they sell a 10% stake they’ll get far less than 10% of the current value.
When taking out a loan, it’s vital to find a product that meets the consumer protection standards. Any product that meets the SHIP standards will:
- Set a fixed interest rate, or define the maximum interest rate for lifetime loans
- Give borrowers the right to remain in their property for life, or until they enter long term care
- Allow borrowers the right to move home, subject to the lenders’ approval
- Include a ‘no negative equity guarantee,’ ensuring borrowers or their estates will never owe more than the value of their home.
What alternatives are there?
If you’re in retirement and looking to free up cash in your home, the alternative is to downsize. Younger or healthier retirees might want to carry on working (or find themselves forced to do so). While personal loans or credit cards might be cheaper forms of borrowing, these won’t be an option for people with low incomes that won’t be able to make monthly repayments.
People facing a shortfall on an interest only mortgage could also consider downsizing, or remortgaging. Traditionally, mortgage borrowing in later life has been difficult, but lots of banks and building societies have been extending maximum ages for mortgages as they recognise many people will be working for longer.
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.
Changing mortgages without moving home. Property owners chiefly remortgage to get a better deal but some do so to release equity in their homes or to finance home improvements, the costs of which are added to the new mortgage. Even though you’re not moving house, you still need to engage solicitors, conveyancing and the new lender will require the property to be surveyed and valued.
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.
This is effectively paying interest on interest. Interest is calculated not only on the initial sum borrowed (principal) or saved (see APR and AER) but also on the accumulated interest. The more frequently interest is added to the principal, the faster the principal grows and the higher the compound interest will be. Compound interest differs from “simple interest” in that simple interest is calculated solely as a percentage of the principal sum.
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.