Equity release – further commentary following Michael Stennett’s article in previous edition of ECA

By Paul Willans

In the last edition of ECA, Michael Stennett gave an informative and interesting analysis of home reversion and home income plans. However, it is fair to say that any discussion of equity release products would be incomplete without reference to other mainstream options, such as interest deferral schemes.

Interest deferral schemes evolved from pure interest-only mortgages and allow an individual, or couple, to release equity in property secured by a mortgage. Unlike an interest-only loan, no interest is ever payable, rather it is accumulated and redeemed on eventual sale of the property - thus providing absolute security of tenure. Unlike other equity release schemes, costs are transparent and the homeowner retains a high degree of flexibility and the benefit of any subsequent rise in the property’s value. There is also the guarantee that the outstanding loan and accumulated interest will never exceed the value of the property and that the homeowner’s beneficiaries will not be saddled with a debt.

As with other equity release schemes, applicants must be at least 60 years old and are limited as to how much equity may be realised, ie, an individual aged 65 would not be able to raise more than 20 per cent of the property value. However, the loan to value percentage does rise on a tiered basis and an individual aged 89 or over could raise up to 50 per cent of the property value. Interest rates are normally fixed for the lifetime of the loan and apply to the original loan and any accumulated deferred interest. For example, a loan of £ 40,000 on a property valued at £200,000 will accumulate interest of £3,196 pa (assuming a fixed rate of 7.99 per cent) that would compound to a total debt of £129,482 (including the capital sum) after 15 years.

However, because the applicant retains full entitlement to any subsequent rise in the property value, it does not follow that the applicant will see an erosion of the value of his original equity position. Using the above example, and assuming that the property value increased at an average rate of 3 per cent pa, the property value would rise to £311,593 after 15 years. If the loan and accumulated interest was then redeemed, the owner would receive net proceeds of £182,111. A more optimistic growth rate of 5 per cent would see the net proceeds rise to £286,303.

Interest deferral schemes can provide pure income or a mixture of income and a capital sum. The income option is normally charged on a variable interest rate basis, but is likely to be a more cost-effective alternative and may avoid unnecessary borrowings.

In his article, Michael Stennett stated that home reversion schemes are the most popular type of scheme; although I would question as to whom they are popular with. Certainly they are heavily sold, as they are unregulated and offer significantly higher levels of commission. Michael did not mention that the amount of equity required in consideration for the cash payment penalises younger applicants and may be perhaps 100-150 per cent of the cash payment. Compared against the above example, a homeowner may need to transfer between £80,000 to £100,000 of their equity to a home reversion provider in order to release £40,000 of capital. Not only does the homeowner forsake future appreciation on the transferred equity, but should they die shortly afterwards, their beneficiaries would be significantly worse off.

In addition, it is difficult to see how an adviser could recommend home income plans at a time when annuity rates are at an historical low. There are now several building societies and insurance companies who offer interest deferral schemes, but care should be taken to compare their interest rates, application charges, redemption penalties and whether there are any compulsory insurance products.

Finally, I would very much agree with Michael Stennett’s comment that applicants should seek to pay a fee for their advice, with any commission rebated, as this should ensure that they receive truly impartial advice on all the options available and, indeed, whether they should proceed at all.”

Paul Willans, Financial Planning Manager, Bells Potter Solicitors