Equity release plans make sense for many elderly clients, enabling them to boost their income by unlocking the equity in their homes without the need to sell up and move to smaller properties.
The equity release market is enjoying a surge in popularity. New business has grown from £44m in 1996 to £524m in 2001. And with older homeowners thought to be sitting on over £400bn of equity, the Council of Mortgage Lenders (CML) estimates that up to £5bn of new business could, in theory, be done each year for the next 10 years.
Only a few years ago, some of the equity release plans on offer from building societies proved to be disastrous as they did not offer the borrowers a guarantee that they would be able to stay in their homes rent-free for life.
The funds were advanced at a variable interest rate and were secured against the property. Much higher interest rates and a collapsing property market in the early 1990s meant that many retired clients found they were being forced out of their homes, leaving them with debts they were unable to pay.
Interest rates have not been so low since the 1950s. Although this has been manna from heaven for borrowers it has not been such good news for those who rely on their savings, because their bank deposits are paying them a relatively small amount of interest.
In fact, according to Age Concern, in the 1999/2000 financial year 34% of people aged over 60 claimed one or more means-tested benefits, such as income support or housing benefit. The problem is compounded by the fact that people are also living longer.
The upshot of this is that the two sides to the equation ‘ the perceived financial needs of the over 60s together with an economic backdrop favouring property as a security for borrowing ‘ have come into alignment and banks, insurers and property investment companies have taken this on board.
In catering for this pent-up demand, new types of equity release products have been developed that do not rely on stock market investments to create an income. Nor do they charge a variable interest rate.
Equity release plans via a mortgage scheme now carry a no-negative-equity clause, so even if house prices fall below the level at which the loan was made, the homeowner will not be liable for the excess debt over the current value of their property.
With such enormous potential demand, and an increasing supply of products on the market, there is a need for brokers and IFAs to research what is available. This will put them in a position to help their clients choose the right plans for their circumstances, particularly since taking out an equity release plan will be one of the biggest financial decisions they will make in retirement.
Most providers pay an introductory fee to the adviser, for example between 1% and 1.5% of the funds paid to the client. The adviser may then help the client to invest part of the cash lump sum.
The next generation
The new generation of schemes coming onto the market falls into two categories: mortgages and reversion arrangements. With a mortgage ‘ the more popular of the two types ‘ the homeowner takes out a loan on their property for a cash lump sum.
However, interest is not repaid monthly but rolled up and paid off at the end of the plan, together with the capital amount. This is usually when the client moves or dies and the property is sold.
The interest rate is fixed or capped, but is relatively high in relation to reversion plans. It is therefore possible for the interest to roll up into a massive sum over the years. However, the homeowner still owns the property and so can benefit from future house price increases.
Under a reversion arrangement, the homeowner sells all or part of their home in return for a lump sum or regular income. They then live in the property rent-free, or for a nominal rent for the rest of their lives, with security of tenure, and they have the added reassurance of being able to move to an alternative property of their choice whenever and wherever they wish. Some mortgage plans require part of the loan to be repaid should a move take place. If the amount of the repayment is too high the borrowers may be forced to move to a cheaper area away from their friends.
When the vendor ‘ or the surviving partner of a couple ‘ dies, the value of the slice of the property they sold reverts to the provider. Any balance of the equity retained by the vendor forms part of their estate.
The proportion of equity released under this type of plan is likely to be much higher than under a mortgage plan. However, the homeowner will be paid less than the current market value of the share of the property that they sell ‘ the usual rate is less than half ‘ because the provider will not see any return on their investment until the property is sold. In effect the discount makes up for the lack of rent being paid by the occupants. Furthermore, the vendor also sells the same proportion of future price increases. This cost will not be known until the end of the plan. Unlike a mortgage plan, a reversion scheme is irreversible.
Finding your market
Equity release products are only available to the over-65s. They are suitable for older people needing to supplement their incomes, as well as those who have purchased annuities ‘ or who are about to ‘ and who are suffering from a drop in annuity rates.
They can also be useful to people who have been self-employed, but who have not built up adequate pension funds. However, research by many lenders shows that often the plans are taken out for aspirational reasons, rather than out of desperation.
The aspirational market is for people who have enough money to live on but want, for example, to access a capital sum for a holiday, to assist with grandchildren’s education, to make their home more comfortable or to reduce potential inheritance tax liabilities.
Whether or not a mortgage or a reversion arrangement is best will depend on individual circumstances, but someone with a shorter life expectancy may be better off with a mortgage. Some reversionary companies will offer improved payout rates if the vendor or vendors are in poor health. However, someone who expects to live another 10 or 20 years will usually get better value from a reversion plan, because a mortgage scheme would roll up the interest until they die. This could end up greatly increasing the amount of the loan.
Reversion schemes are more flexible than mortgages, particularly if the client moves house later. If they move to a property worth less than the one they were in, they will have to repay some of the loan. With a reversion arrangement, however, there is no redemption ‘ the vendor and the provider split the net profit according to the proportion of the original equity sold to the provider. The vendors may also raise money from their home in tranches.
This flexibility is important; because circumstances can change, and even if someone has no intention of moving when they set up an equity release plan, they may find they eventually do so. Around 40% of people move after taking out a scheme.
Whatever the plan, it is always essential to check that your client can stay in their home for life and Crown Equity Release joins other providers in the market such as Norwich Union, AMP, Scottish Widows, Northern Rock, and GE Life in promoting plans that give the vendors security of tenure.
Finally, it goes without saying that anyone contemplating equity release should always seek independent advice.
Mark King is managing director of Crown Equity Release
Equity release is typically used to help borrowers enjoy their retirement, rather than to fund essential day-to-day costs.
Clients can opt for a mortgage-based scheme, or a reversion plan ‘ the correct choice will depend on the individual’s circumstances.
To ensure clients can stay in their homes for as long as they wish, always recommend a plan that offers security of tenure.