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Legal & General trials equity release fixed early repayment charges

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  • 05/05/2021
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Legal & General trials equity release fixed early repayment charges
Legal & General is trialling the use of fixed early repayment charges for its equity release borrowers spanning 15 years.

 

The lender said it was testing the new penalty structure in response to feedback from its brokers.

Up until now, L&G’s equity release mortgages only came with variable early repayment charges.

The move has been praised by intermediaries who have criticised the complicated nature of variable gilt-linked penalties.

Mortgage Solutions understands, on a sliding scale, the early repayment charges (ERC) being tested are: years one to five/9 per cent, years six to eight/8 per cent, year 9/7 per cent, year ten/6 per cent, year 11/5 per cent, year 12/4 per cent, year 13/3 per cent, year 14/2 per cent, year 15/ 1 per cent and in year 16 there is no penalty.

It is not known if these are the final charges that will be used if L&G launches fixed penalties on a permanent basis.

 

‘Highly significant’

L&G’s pilot has been welcomed by brokers.

Chief executive of Key Will Hale said: “Fixed ERCs offer the benefit of transparency and simplicity for customers and, assuming that this move is not accompanied by an increase in interest rates, Legal & General’s decision to offer the choice between gilt and fixed-rate ERCs across all their products should be welcomed.”

Stuart Powell, managing director, Ocean Equity Release, added: “L&G’s news is highly significant. It’s great to hear one of the largest lenders listening to broker feedback.

“At Ocean Equity Release, we have long been asking all lenders to provide clients with a choice in all aspects of their later life lending options.”

Fixed ERCs follow a similar pattern to mainstream mortgage penalties. They gradually decrease by a fixed percentage the longer a plan is held.

Variable ERCs do not behave the same. Instead, they are linked to gilt yields.

When the borrower takes out a lifetime mortgage it is pegged to a specific gilt.

Borrowers who take out a lifetime mortgage when gilt yields are low are likely to pay little or no penalty if they need to pay back the loan a few years later. This is because gilt yields will probably be higher which means the lender can reinvest that money at a better return and therefore has no reason to penalise the homeowner.

If, however, a borrower takes out an equity release loan when gilt yields are high, and wants to repay the debt in a few years, it is likely that gilt yields will be lower, and the lender will not be able to get the same return on their investment.

In that case the borrower is forced to pay a high early repayment charge to compensate the lender which can be as much as 25 per cent of the original loan.

Current gilt yields are much lower than they were between 2010 and 2016, excluding intermittent dips. Anyone who took out an equity release loan with a variable ERC back then and wants to redeem now could be facing a much higher penalty than a borrower with the same loan amount on a fixed ERC.

 

Complicated gamble

Brokers have criticised the complexity of variable ERCs and questioned the suitability of a sophisticated mechanism to calculate a simple penalty.

Powell said: “If you were to ask ten equity release brokers to explain how a variable rate ERC worked, you would probably get five different answers and two who couldn’t explain it without reading the definition.

“Against this background, what chance does a consumer, who is completing their own research, have of understanding the two types?”

Powell says gilt-linked ERCs are often the type of penalties that prevent brokers from being able to remortgage their clients to cheaper interest rates.

“If after eight years a fixed rate ERC has fallen to three per cent, on a £100,000 equity release mortgage the client may have to pay a penalty of £3,000.

“If it was a variable ERC and the penalty was eight per cent on the day of redemption, the client may have to pay £8,000 or it could be £0 or £25,000 [depending on gilt yields]. That is too much of a gamble in my opinion.”

If L&G does adopt the structure being trialled it will be one of the least competitive fixed early repayment charges on the market.

Canada Life uses an eight year penalty, for example. For the first five years, it charges five per cent and then three per cent for the following three years.

More2life uses a 15-year time scale but with lower charges than L&G’s proposed penalties. More2life charges ten per cent in year one and reduces the percentage charge down to 1 per cent in year ten, and then 1 per cent up to and including year 15.

L&G would not comment on how long it planned to test the charging structure or which brokers were involved in the trial.

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