Every year, tens of thousands of older homeowners decide to use their property to pump prime their retirement.
Equity release enables over-55s in the UK to extract tax-free cash from their homes. Across the market, this is happening at the rate of more than £10m per day.
Last year, a record £3.94bn was raised by 83,000 homeowners over the age of 55. Yet the figure could surpass £5bn in 2019 after figures released this week by the Equity Release Council showed the strongest start to any year on record.
Harnessing the huge appreciation in property prices might be filling the pensions gap for older generations, but it can also dash the inheritance hopes of the next — and politicians are also eyeing housing equity as a means of funding social care.
Historically, equity release has had a bad reputation for leaving homeowners and their heirs with big debts when the family home is finally sold. But the industry is now regulated by the Financial Conduct Authority (FCA), resulting in important consumer protections. Nevertheless, there are important pitfalls for homeowners — and their families — to consider.
As the market for equity release surges, the number of providers and types of product is growing fast, giving the over-55s more choice than ever. Here, FT Money presents a practical guide to how equity release works, what homeowners need to consider, plus the tax and inheritance implications.
How equity release works
Homeowners over the age of 55, who own their properties outright or who only have a small mortgage, can release money from their home so long as it is valued at more than £70,000.
They can usually borrow between 19 and 50 per cent of the value of their home, depending on their age and health, and will not have to pay tax on the capital they release.
This can be taken as a single lump sum, but “drawdown” products allow borrowers to withdraw an initial sum, then take further amounts when needed, up to an agreed limit. Other types of loan provide a steady income.
Borrowers will only be charged interest when the money is drawn down. Interest rates are fixed at the time the equity release contract is negotiated, and will not alter if the Bank of England rate changes before subsequent sums are accessed.
The majority of equity release loans are “lifetime mortgages” although there are other types including home reversion plans and specialist “interest only” products (see below). Many people opt to pay nothing back until their property is sold — either when the last borrower dies, or enters a care home.
In such cases, the interest is “rolled up” and added to the loan. Typically, this means the loan will double in size after about 14 years. This is an important consideration for borrowers in their 50s or 60s, as the debt will get bigger through the decades.
However, borrowers can also opt to pay the interest charges, which means the debt will not increase over the years.
Under new FCA rules, standards and guidance have been issued for the industry. Members of the Equity Release Council (ERC) have to abide by its “no negative equity guarantee”.
This guarantees that borrowers — and their heirs — will never owe more than the value of their home, no matter how long they live, even if there is a downturn in property prices.
Given the growth of equity release, worries have been expressed about risks to the wider financial system in the event that this happens. The Prudential Regulation Authority is set to introduce new rules on capital requirements, to be implemented from the end of 2019, which could affect the amounts people can borrow.
Currently, interest rates on lifetime mortgages can be as low as 3.22 per cent with the average new drawdown plan costing 4.22 per cent. The lowest interest rates are offered on loans of £100,000 or more on properties valued at more than £500,000.
Because lifetime mortgages do not require the payment of interest or capital until the property is sold, the income of the borrower is not taken into account. There is also no risk of repossession with equity release because there are no payments to miss.
Instead, the amount that can be borrowed depends on the value of the home, the age of the homeowners and their state of their health. Online equity release calculators can provide a useful guide, but they are not a guarantee of what borrowers will be offered.
Prospective equity release customers are obliged by the ERC to seek financial advice as part of the application process, and have to use a specialist broker to establish which of over 220 equity release product options will be right for their needs.
Some products are flexible and will allow the loan to be “ported” to a new property if the homeowner later opts to move house, or downsize. Others offer inheritance guarantees that enable lifetime mortgage customers to ring fence a percentage of the property value, which is fixed regardless of the total interest accrued by the loan, so they can be confident of leaving behind at least this amount for inheritance beneficiaries. This product option may reduce the maximum amount that can be borrowed.
Borrowers have to take independent legal advice. The ERC website lists FCA-regulated brokers and solicitors that comply with its standards.
Before the loan is taken out, the property value has to be determined by an independent surveyor; a process repeated when the time comes to sell.
Fees for property valuation, financial advice and legal services vary, but must be detailed up front. Many providers offer products with no valuation or arrangement fees. Financial advice fees vary, but paying 2 per cent of the amount borrowed with a minimum fee of £1,500 is not uncommon.
Because of these additional checks and balances, it usually takes six weeks or longer to complete the process. At the end of the term, the lender is responsible for selling the vacated property, meaning no estate agents fees are incurred.
Equity release borrowing hit a record £936m in the first quarter of 2019 — an 8 per cent increase year-on-year, according to statistics this week from the ERC.
This type of lending now accounts for 3 per cent of the overall mortgage market, and roughly one-third of new mortgages taken out by people over 55.
The average age that borrowers release equity is 70 for men and 68 for women. The average new lump sum lifetime mortgage now stands at just under £100,000, with new drawdown customers agreeing an average first instalment of just over £62,000 with an average property value of just over £350,000.
Funding home improvements is one of the biggest drivers of equity release for all age groups, but particularly for older borrowers who need to adapt their homes in order to carry on living independently. Older borrowers are also more likely to use the proceeds to supplement their retirement income, as well as helping family members with housing deposits, according to ERC data.
Younger borrowers (aged 55 to 64) are more likely to use equity release to pay off unsecured debts or existing mortgages, particularly interest-only mortgages which are increasingly tricky for older borrowers to refinance.
Over the past five years, the strongest demand for equity release has been in London and southern regions where property prices have increased the most steeply. More recently the East Midlands and West Midlands have emerged as the fastest-growing regions — up 26 per cent and 20 per cent over a year, according to the ERC.
The over-60s are sitting on £1.7tn of housing equity, so it is perhaps not surprising that equity release equalled 50 per cent of the amount drawn down from pensions last year.
In its paper on the Ageing Population in 2018, the FCA predicted: “In light of pension shortfalls, housing equity will continue to play a key role in later life and retirement planning.”
However, borrowers need to understand how the costs and charges can mount over time before they sign on the dotted line.
Downsides of equity release
Before sweeping new protections and regulations were introduced, equity release had a reputation for leaving heirs with big bills when their relatives died.
Although the FCA and ERC have reformed the worst of these practices, it is still not suitable for all borrowers.
“Equity release has become increasingly popular and while it allows many to unlock money in their property, it can be an expensive way to borrow,” says Gareth Shaw, head of money at Which?, the consumer group.
“It also places a range of restrictions on people should they decide to move later in life. Consumers can also face eye-watering charges if their circumstances change and they want to repay their loan early, so it is important that firms are transparent and advisers ensure customers are aware of what they’re signing up to.”
Despite this, David Burrowes, chairman of the ERC and a former MP, says that equity release products are now among the most highly-regulated financial products in the UK.
“Equity release is the least complained about home finance product sold in the UK,” he says, basing his claim on the latest regulatory data from the FCA.
The Financial Ombudsman Service agrees that numbers of complaints are low, although two-thirds of those it does receive are from relatives of those who have taken out loans. Mr Burrowes says that this can often be the result of family members being unaware that their relative took out a loan.
“It is very important that children and other relatives are included in the decision-making process,” he says, adding that the ERC, brokers and financial advisers all recommend that children or younger relatives are involved in discussions before taking out a loan. In his experience, “most children want their parents to have a comfortable later life”.
However, others may be relying on inheriting money and the thought of this being eaten away by interest, fees and other charges could come as a shock.
Typically, complaints concern early repayment charges or the suitability of the product that has been sold.
Equity release works best if borrowers plan to live in their home long term. If not, they need to ensure their lifetime mortgage gives them flexibility without incurring expensive exit fees. These fees can be 10 per cent of the original loan.
Brokers, financial advisers and independent legal advice are key to ensuring that homeowners understand the pros and cons of equity release.
As well as assessing the mental capacity of the prospective borrowers, they will also consider the impact that equity release could have on their eligibility for benefits — a pitfall that many borrowers overlook.
Mr Burrowes says that some homeowners are advised by brokers that equity release is not for them.
“In one case, a broker discovered that a homeowner was eligible for benefits and they were able to make a backdated claim and also to increase their income by applying for the benefit,” he says.
Future care needs are another factor to consider. Mr Burrowes says most lenders will agree to a borrower sharing their home with a carer or other relative such as a son or daughter, but will almost always insist that the occupier signs a waiver, confirming that they will move out as soon as the homeowner does.
Some providers are happy for homeowners to use the government’s Rent a Room scheme to let a room in their property and earn up to £7,500 a year tax free. But they will want to make sure that the tenants have no rights to continue to live there after the homeowner dies or moves out.
The profile of equity release has been strengthened by major companies such as Aviva and Legal and General entering the market. As the market expands, products continue to evolve.
Mr Shaw of Which? believes that Rio loans — retirement interest-only mortgages — are likely to become more widely available and could be a cheaper way for many to borrow.
Last month, the Nationwide Building Society became the first high street lender to offer later-life products through its branches. These are initially available to existing mortgage customers, but will be available to all homeowners over 55 from this summer.
The financial services sector senses the opportunity, but so might the government. This week, ex-cabinet minister Damian Green caused a stir when he suggested pensioners should consider giving up some of their housing wealth to fund better levels of care.
When Theresa May, the prime minister, floated a similar idea before the 2017 general election, it was quickly branded a “dementia tax” and the policy was never adopted. Given the collapse of care home operator Four Seasons this week, political pressure to reform the social care system is rising, although it is too early to tell how this could impact the rise of equity release in the future.
Other types of equity release
Rio loans — short for retirement interest-only mortgages — were launched in 2018. The homeowner pays back interest and only pays the capital back when they sell up or die. These are often more cost effective than traditional lifetime mortgages, because the interest is not rolled up and interest rates also tend to be lower.
Borrowers should be aware that the amount borrowed depends on the income of the lower-earning partner — the surviving spouse will continue to make interest payments when their partner dies. These sorts of loans are growing in popularity with those who are too old to refinance interest-only mortgages with a conventional repayment loan.
Home reversion plans enable homeowners to sell part or all of their home to a specialist provider at less than the market value and still live in it. They can choose to take a tax-free lump sum or a regular tax-free income. The amounts released are calculated actuarially, taking account of the property value and age of the homeowners.
When the home is eventually sold, the reversion company gets its share of the proceeds of the sale and beneficiaries get the rest. Reversion plans account for less than 1 per cent of the equity release market.
Paul Barber, chief executive of Retirement Bridge, the largest home reversion provider, said that if a client had sold 100 per cent of their property, their estate would receive nothing on their death. If they had taken a partial reversion plan of, say, 75 per cent, the estate would receive 25 per cent of the net sale proceeds upon the death of the client and the sale of the property. All Retirement Bridge products are portable to another property.
The oldest client of Retirement Bridge celebrated her 104th birthday in December. She took out a home reversion plan in 2001 and another in 2007 when she was 92. “Best of luck to her in beating the actuarial tables, which she does remind us of from time to time,” Mr Barber says.
Making life more comfortable
Trevor, 69, and Ruth Stamp, 71, paid off the mortgage on their Ipswich home about 20 years ago. In recent years they decided to make their home eco-friendly by installing solar panels, double glazing and insulation.
“It made the house more comfortable and we were getting the maximum rate for the solar power but were paying £900 a month on the loans taken out to do the work,” said Mr Stamp, a former foreman for a parcel delivery company.
The couple enquired at their bank about taking out a consolidation loan to reduce the monthly payments but were told they were too old. The bank suggested equity release might work for them but could not recommend a provider.
“A friend suggested a broker and we were able to borrow £47,000 last September. We pay £180 interest a month on the lifetime mortgage we took out with OneFamily, which means we have an extra £720 to spend each month.
“We discussed it with our three sons and daughter before we went ahead and they were more than happy for us to do it. The adviser explained everything about the contract and we were happy with the £260,000 valuation on our home. By paying interest the loan is not increasing and we will get the benefit of any growth in the value of our home.
“We had a good Christmas and now have more money for holidays and days out, so we can enjoy our retirement more,” said Mr Stamp.
Letter in response to this article:
Linking equity release and the climate emergency / From Daniel Scharf, Abingdon, Oxon, UK
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