Booming property prices have created a fast-growing market which enables elderly people to release cash from their houses without moving home.
But regulators and actuaries are warning homeowners to beware of sharp practices in the “equity release” market, where many independent financial advisers have failed to explain the risks – such as surging debts – to clients, some of whom are vulnerable and elderly.
Experts say investors should seriously consider other options, such as selling their houses, moving to cheaper homes and using the proceeds to improve their standard of living.
Once the preserve of low-income families who badly needed cash to make ends meet, equity release has gone upmarket in recent years. Some advisers promote it as a way to mitigate potential inheritance tax bills, which have soared in line with rising house prices.
Although the market got a bad name in the 1990s after so-called “shared appreciation” mortgages turned sour, large companies including Abbey, Prudential and Norwich Union have moved in, a sign of their willingness to expose their reputations to a changed environment.
The Financial Services Authority (FSA) said in May, after a “mystery shopping” exercise, that more than 60 per cent of researchers reported that independent financial advisers had not explained the risks of equity release. More than 70 per cent of the IFAs surveyed did not get enough information about their clients to assess whether equity release was appropriate.
The findings of the watchdog’s survey come as parliament debates further regulation of equity release. The FSA already polices lifetime mortgages and the Treasury has said that the watchdog will regulate home reversion plans too.
Such concerns are significant because of the rapid growth of the market, which is 25 times bigger than it was ten10 years ago and hit a value of £1.2bn last year. And equity release could continue to surge: the Institute of Actuaries estimated that people over 65 had about £1,100bn tied up in homes. Demographic and financial trends could also boost the market – life expectancy is rising and people are failing to provide fully for pensions.
The FSA, which has a statutory objective of getting the right amount of protection for consumers, warned financial advisers that it could crack down by using its powers of enforcement. It demanded that IFAs deal with its grave concerns about the suitability of advice given to clients.
The watchdog plans a publicity campaign to warn and inform consumers and will distribute 120,000 leaflets to GP surgeries, Citizens Advice Bureaux, and libraries throughout the UK.
The leaflets will educate homeowners about the two major categories of equity release. Lifetime mortgages account for more than 90 per cent of sales. Under these plans, clients borrow money and interest is compounded at a fixed rate with no repayments during the customers’ lives. Capital and interest are paid from the proceeds of selling the home when the customers die or move into care. Investors should make sure that a “no negative equity” guarantee prevents any further call on their heirs if the value of the loan outstrips the property price.
The second category is so-called reversion schemes, where the company buys a share of the homeowner’s house and the clients live in it rent-free for the rest of their lives. The business pays a low price – for example, £30,000 for a 60 per cent share of a £100,000 home, reflecting the fact that it will be some years before the sale of the property.
As part of the survey, the FSA highlighted specific concerns about using equity release to mitigate inheritance tax, where it said the pros and cons were “very finely balanced”. The regulator said a number of the cases that it reviewed were likely to leave the homeowners’ heirs worse off than they would have been if the client had done nothing.
In these inheritance tax schemes, homeowners borrow against the security of their houses. They then invest the proceeds in a single-premium “whole-of-life” contract, which is due to pay cash to their heirs on death. Next, they give this policy to their heirs. If the homeowners live for seven years or more after the gift, it escapes inheritance tax.
However, trade bodies including the Council of Mortgage Lenders argued that the FSA’s mystery shopping survey was limited and did not represent the market as a whole. The CML believed the market had huge potential to grow.
But Ged Hosty, the chairman of an Institute of Actuaries working party about equity release, says these plans can backfire seriously against homeowners. A 55- year-old customer who borrowed £30,000 at a 6.75 per cent interest rate would find the loan had grown to £110,784 by the age of 75. While house prices may grow and offset the loan, Hosty advises consumers to work out how much the debt could grow to.
Hosty, the managing director of In Retirement Services, an equity release adviser, says: “If a homeowner lives for 20 years, the interest rolls up on the loan and it is going to overtake the inheritance tax benefits. The interest charge will erode any advantage after a certain period.”
Despite such risks, Hosty adds that equity release can improve the standard of living for people who have considered all the options and taken informed decisions.
Ali Crossley, the director of lifetime mortgages at Prudential, a life assurer, says the lack of pension provision is the key factor behind the existence of the market. She says that people who have not invested enough to generate the income they want after retiring pin their hopes on their homes.: “Our property is our pension.”
Adair Turner, the chairman of the Pensions Commission, said in last year’s interim report that 20 per cent of people moving between homes with no mortgages did so mainly to trade down and raise cash.
All of this demonstrates that the stakes are high for those assessing their options duringfor life after the final payslip.
The risks could include surging debt and misunderstandings with family members. But for those who have weighed up all the options, there may be benefits.
