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Is equity release a viable source of income?
Say 'equity release' to many people and they will remember the unregulated market of 20 years ago, where house price inflation meant that many borrowed more than they could afford and were left servicing spiralling property debts.
But today equity release is fast becoming a viable source of income for many pensioners who are asset-rich and cash-poor.
More than 70% of people would consider using equity in a property as part of their later life finances, according to figures from trade body the Equity Release Council (ERC), formerly known as Safe Home Income Plans (Ship), which shows equity release has overcome the stigma it has carried around for so long. "The stigma of equity release has already disappeared," says Steve Lowe, director of external affairs at equity release provider Just Retirement. "Things are wholly different now to 20 years ago."
Equity release is a way to extract cash from your home, while still being able to live there. Schemes are typically available to those aged between 55 and 70. The most common schemes are mortgage-based, with the lifetime mortgage the most common. It makes up around 98% of the equity release market, and behaves like a standard mortgage. Interest will be charged, but it will usually be rolled up into a chunk, which is paid off on death. Income is then drawn down gradually, and interest is only charged on the money actually borrowed.
The rest of the market is taken up by the home reversion plan, which involves a company buying all or part of the property for a proportion of its market value, in return for a regular income.
Interest rates can be punitive. A lifetime mortgage will charge around double the rate of a standard mortgage, with anything from 5% to 8% the norm, which means on average the debt doubles roughly every 10 years. Put simply, if you borrow £100,000 today, you’ll owe £200,000 in 2022.
Erratic stockmarkets, low interest rates and rock-bottom gilt yields have created the perfect storm for equity release, as lending in the industry has soared. Total lending across the market rose to £217.1 million in the first three months of 2012, while sales of equity release plans rose 6.4% to 4,508 from January to March this year, up from 4,237 a year earlier, according to figures from Key Retirement Solutions.
The sudden interest is two-fold, according to Just Retirement's Steve Lowe. Babyboomers approaching retirement, plus a large group of borrowers with poorly-performing endowment mortgages, are both turning to equity release.
Lowe warns that the market could explode as borrowers find their ill-fated endowment mortgages haven't performed as expected, and fall short of covering the outstanding balances. "There are around 25,000 people each year that have an endowment shortfall. Over the next 10 years, that's an estimated 250,000 people with mortgage balances to pay off, yet with billions tied up in property," he says.
Meanwhile, the babyboomers are contending with depressed gilt yields and volatile stock and bond markets, which has led to their retirement income falling. Research from insurer LV= shows that more than six million people over 50 will retire on just £5,890 a year, which equates to less than the minimum wage, yet with considerable sums locked in their property. Equity release is one way to counter pensioners living in poverty, says Lowe.
Self-regulated by the ERC
The market is now self-regulated by the trade body ERC, which insists on a strict code of conduct that its member providers must adhere to. The code includes rules that allow customers to live in their property until death, while also allowing customers to move the plan to another property without financial penalty, plus a "no negative equity" guarantee on all plans, meaning that you can never owe more than the value of your home. Equity release products are now fully regulated by the Financial Services Authority (FSA), providing another level of protection.
The market is also innovating in line with increased demand. Retirement specialist Partnership last year launched an equity release product directed at those with long-term illnesses, or those who smoke. By using medical underwriting, it aims to release up to 25% more cash from a home than a traditional scheme. Meanwhile, charity Age UK has entered the market, lending credibility to the industry.
Vanessa Owen, head of equity release at LV=, highlights the advent of more flexible lifetime mortgages, where you set up a "facility" - which works like a credit limit - and take income as and when you like for a set period. She adds that several providers have debated schemes that act like traditional mortgages, where you start by paying the interest monthly, before rolling the interest up like a standard lifetime mortgage.
However, equity release isn't a one-size-fits-all product. "Only consider equity release when you know there is no available cash from other sources," Owen advises. Downsizing - moving into a smaller property - is one option, as well as considering any grants or benefits you might be entitled to, which could prop up your income without the need for equity release.
Consider carefully how much you need, rather than how much you want. Interest is only paid on the money borrowed, so make a detailed list of spending requirements. Most providers will lend about 20% of the property's value if you’re under 65, rising to around 50% for those aged 90 and above. "Once you’ve made the decision to take out a plan, think what you actually need the money for, as there will be future financial needs to think about as well," says Owen.
She claims interest rates on lifetime mortgages have been falling this year, and are now much cheaper than they were a year ago, although current interest rates on a lifetime mortgage range from 6.1% from insurer Aviva to an eye-watering 7.7% from equity release provider More 2 Life.
Additionally, the market looks set for another boost thanks to the rising cost of long-term care. As life expectancy increases, the number of people that will need long-term care will increase 37% by 2025, according to figures from LV=, with care costs averaging around £30,000 a year.
"Customers will have drawn down all pension income and other investments by then," says Lowe, making equity release a "no brainer" when it comes to covering long-term care costs. The government is poised to publish a White Paper responding to the Dilnot report, and many providers expect equity release to be touted as a way to cover care costs.
Lowe concludes "We all expect that the wealth tied up in property will become a solution in later life."
Be careful and remember interest rates are high
Always choose a plan from a member of the ERC, as it offers several guarantees, including never dipping into negative equity and being able to stay in your property until you die. Plus, it insists you won't be able to take out a plan until you’ve had full financial and legal advice, so you can't sleepwalk into it.
Involve your family and children in discussions. Equity release means your children will be left with less when you die, so it's important they are aware of the process.
Look at the terms and conditions of your chosen scheme. Does it, for example, forbid you from moving into a different property? Most lifetime mortgages will allow this, but few might not. Remember that once you have chosen a scheme, you can't change your mind.
Forget to think about the other implications of equity release. For example, if you claim council tax benefit, income from equity release could mean you are not entitled to the same means-tested benefits as before.
Ignore the cost. Compounded interest rates can be incredibly punitive and could leave little left in terms of value of your home. Equity release is typically a last resort, and should only be used once all other options have been considered.
Borrow the maximum amount of money that a provider will lend you. Interest charges are high, and borrowing an extra £10,000 will turn into £30,000 in 20 years' time.
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