In the past, equity release has developed a bad name for itself, but this is not surprising given the problems with early products launched in the equity release market. However, the industry has responded and its poor reputation is becoming a thing of the past.
A look at some of the factors affecting the income of those in retirement means these types of schemes can no longer be ignored. Inadequate State pensions falling year-on-year in terms of earnings mean it is unlikely any current or future Government will find the money to fully reinstate the historic earnings link. In addition, inadequate private pension provision means only the lucky few have amassed sufficient pension provision to live comfortably in retirement.
Asset-rich or cash-poor?
So what about everyone else? For an ageing population with inadequate pension provision, equity release has a major role to play in filling the income gap. The label ‘asset-rich cash-poor’ is an apt description of many pensioners who struggle for day-to-day income, but are in possession of a house that could have substantial ‘ albeit locked-up value. As graph one (on page 24) shows, more than half of the over 60s own a property without a mortgage.
The original concept of equity release was a good one, but with the benefit of hindsight the products sold in the early 1980s just did not match up to customers’ requirements.
These early products followed a simple formula ‘ the precise details are not too important, but in simple terms, customers borrowed money secured against the value of their residential property. The cash borrowed was then immediately invested and the income that investment produced was used to make the capital and interest repayments on the loan. As long as the income generated exceeded the loan repayments, customers would be left with surplus income to be used in whatever way they wished.
This seems very attractive on the face of it, as long as the investment returns exceeded the loan interest. But the problem was this relationship was not guaranteed, no matter how safe it looked on paper. So when investment returns fell faster than the loan interest rate, this surplus income disappeared. In time, the only way to find the loan repayments was to use other sources of capital, or by selling the house ‘ not the way the customer ever envisaged releasing their equity.
The answer came in the form of better product design and, crucially, important and valuable guarantees. At the moment the most popular form of equity release scheme is the roll-up mortgage. These differ from the earlier product designs in a number of key areas.
First, they are not traditional mortgages. Rather than requiring regular interest and capital repayments, the loan simply rolls-up with all capital and interest repaid out of the proceeds of the house sale following the customer’s death.
Second, all the cash released is available to the homeowner to use as they wish ‘ there is no requirement to invest in a particular way, or to rely on the differences between the income generated and interest payable.
Third, many products offer fixed interest rates on the loan ‘ the homeowner has certainty over how much will need to be repaid, were they to die at any given point in the future.
Finally, such products are provided with ‘no negative equity’ guarantees. When the homeowner dies, even if the loan plus interest exceeds the current value of the house, there is no burden on the estate. Only the house’s value would be repayable.
The other new product was reversionary equity release schemes. This is where the homeowner sells their home to the provider in return for a cash sum and/or an income plus a lease for life. They allow guaranteed continued residence, but their popularity is declining relative to the newer mortgage-based schemes.
These latest schemes have moved the equity release market forwards considerably, but potential equity release customers are older than typical mortgage buyers and, understandably, need additional safeguards, security and peace of mind.
In 1991, an organisation called Safe Home Income Plans (SHIP) was established. Dedicated entirely to the protection of equity release policyholders and the promotion of safe home income plans, it places certain restrictions on the product providers that form its membership. In order for an equity release product provider to be a member of SHIP, its products must meet a number of basic requirements designed to safeguard the interests of the customer.
Individuals releasing equity through a SHIP-member company can do so safe in the knowledge the product they are buying meets these criteria and their interests will be well served by the company they are dealing with.
In particular, buying a plan from a SHIP member company ensures the customer never loses their home ‘ whatever happens to the stock market or interest rates. This is a vital assurance for anyone considering equity release. Buying a product that does not conform to these standards could be dangerous for unsuspecting consumers.
There are a number of other borrower safeguards in place now, depending on the type and size of the equity release scheme.
These include the regulation of the provider by the Financial Services Authority (FSA), the requirements of the 1974 Consumer Credit Act and the voluntary Mortgage Code of Practice introduced by the Council of Mortgage Lenders (CML).
Although equity release may seem to be an ideal solution to the needs of many older people, penetration of such schemes into the market is still very low. One of the reasons for this is a fairly common feeling among older people that their homes serve a dual purpose ‘ somewhere for them to live and an inheritance for their children and their grandchildren. In many cases, however, their children see things differently.
A few years ago, we commissioned some research to try to understand how attitudes towards inheritance varied between different generations. The results showed a clear shift from one generation to the next (see graph two).
Among the over 60s, one in four felt it was their duty to leave a legacy to the next generation and almost half ‘ a further 49% ‘ said they would, ‘like to leave something.’
Stepping down a generation to the 40 to 55-year-old age group, only 3% felt their parents had a duty to pass wealth onto them and a mere 6% expressed the view they hoped their parents would leave them something.
This research indicates there is a whole generation very keen to pass on assets to their children, while the majority of those children neither need nor want that wealth, preferring instead that their parents use and enjoy their money while they are still alive and able to. And that is clearly where equity release can fill an important gap.
The equity release market has a clear role to play in satisfying the financial needs of a growing proportion of the population.
While some of the reputation the market has may have been justified by the products of the past, the equity release products of the twenty-first century bear little resemblance to those of the early 1980s. They are now much safer and more closely monitored to ensure they are suitable for the needs of their target market. Older consumers can and should buy with confidence in the valuable guarantees they are being given.
Paul Shallis is product manager at GE Life
New products come with guarantees of no negative equity.
The SHIP symbol guarantees that the borrower will never lose their home, or have to move out.
The FSA, the Consumer Credit Act and the CML also govern product providers.