However, among affluent and high-net worth (HNW) segments, RIOs are becoming an increasingly common option for older people looking to release significant equity in their homes as part of wider financial and inheritance tax planning, including those looking to gift funds, perhaps to children or grandchildren.
For borrowers, RIOs can often represent a more attractive alternative to selling down investments and shares, particularly when stock markets are volatile, and when they have one, if not multiple sources of income to service the interest payments.
For wealth managers and other professional advisers working with wealthy clients, RIOs can provide an alternative to disinvesting. For intermediaries active in affluent markets looking for a flexible option for their older or in-retirement clients, RIO mortgages deserve a very strong look.
Different from equity release
While on the surface RIOs appear similar, they differ from the equity release products which have been in the spotlight recently and which have been reviewed by the Financial Conduct Authority (FCA) following negative experiences of some borrowers.
With a RIO mortgage, people pay regular interest on the borrowed amount, with the loan repaid when they move into long-term care, sell the property or pass away.
Under equity release, in contrast, interest rolls up, and borrowers end up paying interest on interest, which can prove significant as it eats into the equity of a property. If someone taking out equity release in their 60s lives into their 90s, there may be nothing left to hand on to the next generation.
An RIO mortgage allows a client to protect their equity. While they will initially pay a higher rate of interest than is charged on an equity release mortgage, they may well pay less interest in the long term.
A need to manage estate planning
Hampden and Co has offered retirement mortgages since 2021 to help wealthier people with a need to manage their estate planning later in life, particularly in relation to inheritance tax. These clients have reliable sources of income that can cover interest payments.
Similarly, many clients want their children to benefit from the passing of their wealth during their lifetime. Others simply want to access a lump sum without disturbing other assets and investment portfolios.
A lack of differentiation and understanding
One challenge to greater uptake in RIO mortgages has been a general lack of awareness of RIOs in comparison to the better-known equity release products, as well as an historic lack of differentiation and understanding of the key differences between them.
When thinking about taking a RIO mortgage, people must consider their income to ensure they can afford the interest payments throughout their retirement.
Borrowers may also consider the seven-year timeframe needed to optimise gifting and whether there is a benefit to taking out life insurance to cover any liability.
However, even in this interest rate environment, where rates have recently risen to more historically normal levels, the benefits of RIO mortgages remain, particularly when you consider the difference between inheritance tax at 40 per cent and a total cost of borrowing of, say, around eight per cent.