Sarah Ross: Piling on debt

Bank of England figures released yesterday show that lending to individuals has risen again - to just over £1,000bn in September, about £21,000 for each adult in the UK. Of this debt, £852bn is secured against property and the rest is consumer credit.

Not only are we getting more indebted, but it is taking us longer to become debt-free. The traditional financial life cycle theory held that people in their 20s save little (being low earners and having few responsibilities). In their 30s, the theory continued, they continue to save little and get more in debt (because they have to buy houses and pay for young families), but that in their 40s and 50s they have more leeway to save for their retirement. By the time you reach your 60s, you would not only have paid off your mortgage but would have put away a reasonable amount for your declining years.

Research out this week suggests that this is no longer the case. A total of 588,000 people aged 65 and over still have collective debt of £8.42bn, including mortgages worth £6.08bn, according to Economic Lifestyle, a retirement housing and finance business. In the same age group, 1.15m owe more than £952m on their credit cards. Although these numbers pale into insignificance compared with the overall debt number of £1 trillion and total credit card debt of £60bn, they do suggest a significant shift in patterns of borrowing and saving.

Clearly, part of the reason for increased indebtedness among older people is the inadequacy of the state pension and long-term care provision. Poverty among retirees is a worsening problem which has been highlighted by charities such as Age Concern.

But truly poor pensioners are not likely to be able to borrow, and it must be wealthier older people who are still servicing debts such as mortgages into their 70s.

There are several possible explanations. Social changes such as higher rates of divorce mean that people in their 40s or 50s may have to take out a new mortgage or finance two families.

A harsher explanation is offered by Clive Hamilton, executive director of the Australia Institute, a left-leaning think-tank. “Britons today feel more materially deprived than their parents and grandparents in the 1950s, despite being three times richer,” he wrote in a Cambridge University paper last year. Hamilton believes that much middle class malaise stems from a culture of over-consumption that has contributed to record personal debt levels.

Whatever the reason for the debts, getting out of them can be more of a challenge in your 60s than in your 30s.

Economic Lifestyle suggests (unsurprisingly, because that is its business) that older people should consider easing the financial strain by releasing equity from their houses. It estimates that retired homeowners have about £1 trillion of equity tied up in their properties.

Equity release comes in two forms:

■ Reversion schemes allow homeowners to sell all or part of their home, typically at a 50 per cent discount, and remain in their house.

■ Lifetime mortgages loans secured on the property that are repaid after the owner dies or goes into long-term care.

The market is growing fast. The Council of Mortgage Lenders says that, last year, 25,000 lifetime mortgages worth more than £1bn were sold, an increase of 69 per cent on 2002.

And the appeal of equity release is obvious. “Many customers see equity release as something that they don't have to pay back,” says Norwich Union, the largest provider of lifetime mortgages.

Norwich Union says the average age of its equity release customers is 72, but that it is seeing growing demand from people in their 60s. “Historically, equity release would have been a last resort for people in their 80s,” it says. “But increasingly it is being used by people to fund their lifestyle.”

Independent financial advisers are keen to push equity release products at the older market, one of the reasons being the juicy commissions on offer. The fact that these products are targeted at a vulnerable group is one of the reasons why the FSA has included lifetime mortgages in its new mortgage regulations, to be implemented on Monday, and why home reversion plans will be included in the future.

The need for increased regulation is not the only reason to be cautious. Borrowers need to be wary of the high cost equity release.

On a typical lifetime mortgage, a borrower might pay a fixed annual rate of about 7.5 per cent. Norwich Union's variable rate mortgage has an interest rate of 4.9 per cent plus RPI, capped at 10 per cent. The interest is charged to the loan each year and, while the more respectable providers guarantee that the value of your outstanding mortgage will not be more than the value of your home, the amount owing mounts up very quickly.

“The rule of thumb we use is that what you borrow will double after 10 years and treble after 15,” Norwich Union says.

If you borrow £100,000 on a £500,000 house and survive for 20 years, it is likely that the equity release provider will be owed close to the entire value of your house, although, after fees, you will only have received less than a fifth of its value.

Home reversion plans, which account for about 10 per cent of the equity release market, are also expensive and, in addition, are not expected to be regulated for at least three years. With a typical scheme, a couple, both 70, who sold half their £500,000 house to a commercial company would receive £98,600 (ie £151,400 less than the value of the half-share). If the house was sold 10 years later for, say, £600,000, the reversion company would receive £300,000 - the equivalent of 9.75 per cent interest on its original £98,600, plus £50,000 the increase in value of the portion of the property it owned.

As well as being currently unregulated, there are concerns that home reversion plans may fall under the new “pre-owned assets” legislation, designed to clamp down on inheritance tax avoidance, and will thus incur an income tax charge.

Current uncertainties aside, there is no doubt that a less expensive way to clear debt is simply to move to a less expensive house.

But it's not often that you hear financial advisers recommending that.

sarah.ross@ft.com