What is equity release?
Equity release is a means of freeing up some of the value locked away in a property and turning it into a cash lump sum for the homeowner. It is a product designed for older borrowers, usually retired people over the age of 60, who must own their own freehold property with little or no mortgage left to pay on it.
There are two types of equity release schemes: the roll-up mortgage ‘ sometimes called a lifetime mortgage ‘ which is the most popular option; and the reversion scheme. The key to equity release is that the homeowner does not have to make regular loan repayments. Instead the equity release provider is paid back from the proceeds of the house sale when the homeowner dies or goes into care. Of course the homeowner can settle the debt early, but there are usually early repayment penalties.
Why all the interest now?
The market for equity release is predicted to increase five-fold over the next five years. With the uncertainty surrounding income from pension schemes, coupled with falling returns from stock market-based investments, many people facing retirement are looking for alternative ways of funding their latter years and ensuring they maintain a high standard of living. The sad truth is that in years to come many pensioners could find themselves struggling to survive on a private pension much lower than they hoped for, topped up by a meagre state pension, while living in a house worth a small fortune.
Equity release has been popular in the US for many years and now some of the biggest financial services providers are offering products tailored to the UK market. The cash the homeowner gets from equity release can be used for any purpose but it is commonly used to make home improvements, reinvested in an income plan, or given to family members.
Hasn’t there been a lot of controversy about equity release?
The main concern over equity release is that the debt owed to the lender will be bigger than the remaining equity when the house is sold. As the debt is usually only paid back after the death of the borrower, or if they have to go into care, this could mean that it is the borrower’s surviving family who will be liable for the resulting debt.
In the 1980s so-called home income plans caused a lot of misery for homeowners who remortgaged their properties in a scheme that included a stock market-linked investment plan. But as the interest rate on the remortgage increased, and returns on the investment fell, borrowers were lumbered with a debt bigger than the value remaining in their property.
Many of the new style of equity release plans include guarantees to protect homeowners. The Portman Building Society’s No Negative Equity Guarantee ensures that borrowers never owe more than the value of their home. Portman, along with many other leading lenders, is a member of Safe Home Income Plans (SHIP), an organisation set up to promote equity release type products and protect the interests of borrowers.
SHIP has a code of practice that all members must follow. They protect the homeowner by guaranteeing the following:
• the homeowner will never be asked to repay more than their home is worth;
• the right to move house and take the deal with them;
• potential customers will be encouraged to take independent legal advice.
According to SHIP, its members sold 12 times as many products in 2001 than in the organisation’s first year, 1996. Total cash advances made by members in 2001 amounted to £600m.
What is a roll-up mortgage?
A roll-up or lifetime mortgage is the most popular of equity release products, accounting for two-thirds of all the schemes taken out in the UK. The borrower usually takes out a fixed-rate mortgage for part of the value of their home, a sum between a set minimum advance and a maximum amount which is a percentage of the property’s value, based on the homeowner’s age.
Interest is charged on the mortgage but instead of being paid off month by month like a traditional mortgage, the interest is rolled-up. When the borrower dies or has to go into care, the loan plus the rolled-up interest is repaid from the sale of the property.
Roll-ups are popular because the homeowner retains total ownership of their property. Although they generally allow the homeowner to raise less money than the alternative reversion schemes, the maximum loan amount does increase as the borrower gets older. There are usually penalties for early repayment, but if the lender is a member of SHIP, they provide the peace of mind of fixed interest rates and guarantees against negative equity.
Roll-up mortgages will also be regulated by the Financial Services Authority (FSA) in 2004.
What is a reversion scheme?
A less popular form of equity release, the reversion scheme lets the homeowner sell part of their property to a reversion company in return for a lump sum. The difference is that because the homeowner is not taking out a loan there is no interest to pay. When the homeowner dies or has to go into care, the reversion company claims its percentage of the property.
However, reversion schemes give the owner less for a share of the property than its actual market value, again depending on the owner’s age. For example a 70-year-old with a property worth £200,000 would only get around a fifth of its total value, £40,000, for selling a half share worth £100,000 to a reversion company. When the property is sold, the reversion company takes its half share of the proceeds, realising a profit of the difference between the final sale price and its original advance.
At present, reversion plans are outside the scope of FSA regulation because it is a sale of property rather than a loan. However, many reversion plan providers are members of SHIP so will abide by its code of practice.