Feature

posted 3 Aug 2006 in Volume 11 Issue 5

Assessing the growth of equity-release schemes

Since its launch in 2004, the Help the Aged equity-release service has become one of the largest independent specialists operating in this field. Director Peter Fisher takes a look at the current state of the market.

The growth in the equity-release market has been nothing short of explosive. The Council of Mortgage Lenders [CML] estimates the market potential at up to £100bn while 2005 generated just over £1.2bn of completions. In response to demand, Help the Aged launched its whole of market equity-release service in 2004, and it has already received over 10,000 enquiries.

There are several reasons for this growth, the first being financial. Sustained house-price inflation, low rates of pension escalation relative to costs of living, low interest rates for both savers and borrowers, poor investment returns, a greater number of estates suffering inheritance tax, and greater lender competition and scheme innovation, have all played their part.

Demographically speaking, equity release has enormous appeal for an increasingly ageing, but growing population of asset-rich but income-poor retired property homeowners.

Public confidence in this area has also been restored, thanks largely to new regulation, the FSA and prior work of SHIP (Safe Home Income Plans). Inclusion of reversions next year, and the requirement for advisers to hold specific additional equity-release advice qualifications will further help stimulate growth. While confidence has grown, attitudes have changed. The stigma of equity release being a ‘last resort’ solution for families in financial crises is now being increasingly replaced by the retired wishing to have a full and active life. Their home is seen as a means of having their cake and eating it. If that action also reduces inheritance tax, so much the better. Why survive on pension credit only for your estate to then be subject to inheritance tax when you die?

And, finally, the market has opened up, making offerings more competitive. The past two years has seen a major increase in the number of providers entering the market as well as significant developments in products in both rate and flexibility. The increased competition has seen the historical ‘mark up’ on fixed-rate lifetime mortgages reducing from 2.5-3 per cent above Bank of England base rate. Not now. Aggressive competition for market share among the lenders now means with bank base at 4.5 per cent, interest rates as low as 5.70 per cent are available to Help the Aged clients (as at 6 June 2006).

Buyer trends

As part of its service to provide unbiased and accurate advice, Help the Aged aims to educate its applicants before asking them to complete an eight-page fact-find, which enables the applicant to put in their own words their aims and aspirations for considering this option, without any undue influence. By taking this course of action, of those that completed the forms, approximately 40 per cent were advised not to pursue this route. Some were too young – often those in their fifties were recommended to draw down other savings first or consider an ‘interest only’ option. Others had insufficient equity in their home, while there were those who were advised to claim means-tested state benefits. Two other reasons that made this route unsuitable were that the matter had not previously been discussed with family, or as recommended in the recent report in Which? magazine, the merits of downsizing had not been considered.

Of the rest who were identified as potentially benefiting from taking equity release, the purposes stated included:

Increasing income to maintain preferred lifestyle;
IHT mitigation;
Making gifts to family, assisting house purchase;
Paying for home care;
Improving lifestyle including extra holidays, motor homes and second homes;
Home improvements;
Paying for private medical procedures;
School and university fees;
Paying off serviced loans;
Financing weddings.

About 30 per cent of buyers could be classed as crisis purchasers. Motives may include: needing extra income to live; struggling with debt they cannot service; replacing items such as a car; or completing essential repairs to their home. Over half (55 per cent) fall into the lifestyle category. Here, the aim is to maintain their preferred quality of life and in order to do this, drawing down income or capital. Generally, leaving an inheritance is less of a priority. The remaining group are motivated by IHT-mitigation benefits and being ‘living givers’, usually to their immediate family.

Historically, virtually all applicants opted for a lump sum. However, more now elect to take either a regular income or set up a drawdown facility. This has the major benefit of limiting the interest charged to just the amount actually received. Why borrow more than you immediately need if the excess just resides on deposit, earning at best, three per cent net against the debt rate of about 6.25 per cent APR?

It is even more dubious for any professional financial adviser to suggest reinvestment of the capital raised into long-term investment products. Unless a return greater than the debt charged can be guaranteed, how can it be justified? It can hardly be best advice to recommend a loan charged at an effective rate of the difference, that is, 3.25 per cent for your own money!

Lifetime mortgage or reversion scheme – what is best?

As readers will be aware, equity release is the generic term that covers all methods of releasing funds from residential property for elderly home owners aged usually 60 plus. This is normally financed either by a lifetime mortgage or a reversion. A lifetime mortgage is a loan on the residential property secured by a first charge. There are no payments to the lender and the debt rolls up until redemption after the property is sold. This event is usually triggered after death, moving into long-term care or possibly downsizing. Maximum loan to value will range from 25 per cent at age 60 to 55 per cent at age 90.

With reversions, the homeowner sells all or part of their property to a reversion company at a discount. They do not pay rent for that part of the property sold.

Any growth on the reverted part of the property belongs to the reversion company. The discounted value that the homeowner receives is linked to age and life expectancy – the older you are, the higher the percentage received. Typically, the maximum will be about 60 per cent of the portion sold.

As the above reveals, equity release is one of a very select band of financial products that are age positive to the home owner.

Which of the two options will be more appropriate? Table one will act as a good starting point for clients.

Currently, about 90 per cent of completions are for lifetime mortgages. This may in part be due to the bulk of schemes being mortgage based, given that half are sold by national high-street brands and lifetime mortgages tend to be more flexible.

Until recently, product innovation had been limited. Most schemes just offered a lump-sum facility and that was that. Consequently, a high proportion of completions were set at the maximum loan to age – neither particularly scientific nor necessarily guaranteed to provide the most beneficial solution to the client. Increasingly these days, ‘drawdown’ type schemes offer a more client friendly solution. The debt grows at a lower rate and loss of state or local authority means-tested benefits can potentially be avoided.

Safeguard checkpoints

For those advising clients wishing to take out an equity-release scheme, there are a number of issues that may arise and which should be borne in mind.

The client did not really understand what they were getting into and should not have borrowed in the first place.

A key measure to mitigate against this risk is that the solicitor completes and signs a solicitor’s certificate confirming that it has been pointed out to the client that they need to get advice on several important areas. For the solicitor to act for them, the client has to be considered in good mental health. If not, the client will need to be represented by their attorney under an enduring power of attorney.

The client may be in danger of borrowing too much

With the increasing availability of flexible drawdown schemes, clients have highly attractive alternatives to taking the lump-sum route at outset. The best protection against a future complaint is that the client must justify the need for the money and when they intend spending it.

The client has been sold the wrong product

All sales are based on the information collected at the fact-find and the products available at the time. The appropriateness of the product must be documented in the adviser’s suitability letter and sent to the client prior to proceeding. Solicitors should try to obtain a copy and be comfortable with its contents.

Taking equity release has resulted in the loss of state means-tested benefits

As part of the adviser’s fact finding, important questions as to the client’s capital and income must be established. These figures should then be cross-checked against the rules for receiving state benefits. Any potential loss of benefits must be highlighted to the client and the benefits shown to outweigh the losses. An alternative drawdown type arrangement may offer a solution that preserves the entitlement to state benefits.

Equity release and long-term care

Extreme care must be taken if equity release is being considered as an option to meet long-term care costs. The charity recently came across a case where capital was being taken from the family home to fund a partner’s care costs in a private care home. That adviser had failed to understand that by doing so, the local authority would then not be legally required to contribute towards the care costs. In addition, that adviser failed to also point out the additional non-means-tested benefits to which the client in care was also entitled.

Property maintenance

This is a crucial aspect of the mortgage. It is in everyone’s interests that the mortgaged property is well maintained. Who pays for this and the client’s responsibilities should be properly documented in the supporting literature and the key features information document, and then highlighted by the solicitor.

Checking out the provider/adviser

There are three main ways an applicant can arrange an equity-release scheme. They can go to an independent financial adviser; an adviser who represents one plan provider; or go direct to a company offering a scheme.

An applicant needs to make an informed decision before entering into a scheme. An independent financial adviser should be in a position to advise on various schemes. However, the level of advice given will depend on the adviser’s equity-release expertise, and also their knowledge of matters relating to long-term care. For example:

What is the background to the provider/adviser – tied or independent?
How long has the provider/adviser been established?
What experience does the provider/adviser have in advising on the particular scheme?
Has the provider/adviser covered all the different options with the client or just one?
Has the provider/adviser set out clearly to the client the key features of the scheme?
Has the provider/adviser provided a suitability report?
How safe and sound are the recommendations?
What is the regulatory status of the provider/adviser?
What are the safeguards/protection for the client?
Have all the fees and charges been fully disclosed?
Will the applicant and provider receive independent legal advice?
Is the provider/adviser committed to providing an after-sales service?
How flexible and supportive is the provider/adviser in response to possible changes in circumstances?
Have issues relating to state benefits/ long-term care been satisfactorily answered by the provider/adviser?

Solicitors acting for the elderly client have a crucial role to play during the remortgage process. Their actions should seek to validate or challenge the methodology of the transaction. If it doesn’t look right, it probably isn’t!

FAQ: Equity-release options

How does this type of equity release work?

Home reversion scheme: You sell all or part of your home to a reversion company, in return for them allowing you to live in the property for the rest of your life.

Lifetime mortgage: You take out a loan against the value of your home, either as an interest-only mortgage, whereby you borrow a lump sum and pay monthly interest to the lender, or as a roll-up interest loan, whereby you borrow a lump sum or take a monthly income (or both). The rate of interest can be fixed, variable or capped.

Would I still own my home?

Home reversion scheme: You would no longer be the sole owner of your home (if you sell your entire home, you will no longer own any part of it).

Lifetime mortgage: You would retain full ownership of your home.

How much money would I be able to raise?

Home reversion scheme: You would not be offered the full ‘market value’ of your home but a percentage of its value according to a number of factors including your age, gender and state of health. There could be the option to raise a larger amount than with a lifetime mortgage as you can typically sell anything from 25 per cent up to the whole of your home.

Lifetime mortgage: How much you would be able to borrow would depend on the value of your home and your age, but it is typically 20 per cent to 50 per cent of the property value.

How much money will I ultimately owe/have to pay to the company?

Home reversion scheme: The market value of the portion of your home now owned by the reversion company.

Lifetime mortgage: This would be dependent on the size of the ‘loan’ and the length of time the debt is outstanding. This amount would be increasing all the time as the interest ‘rolls-up’.

Would my health affect which type I choose?

Home reversion scheme: In cases of poor health, enhanced rates may be available.

Lifetime mortgage: Impaired life arrangements are available through some companies, although typically a lifetime-mortgage provider would not take a person’s health into consideration to determine the rate offered.

Which is more flexible?

Home reversion scheme: A home reversion scheme is typically less flexible than a Lifetime Mortgage as the portion sold is usually taken as a single lump sum. A very small percentage of reversion companies, however, will allow funds to be drawn down over a 10-year period and/or additional portions of the home to be sold in the future subject to the company’s criteria.

Lifetime mortgage: There is currently a far wider choice and variety of lifetime mortgages available. There would also be the option to release more capital with age and/or as the home value increases.

What impact would rising house prices have?

Home reversion scheme: The increase in the value of the portion of your home sold would go to the reversion company rather than to your estate. Therefore this is potentially a more suitable option to consider if you believe house prices are not going to rise significantly.

Lifetime mortgage: Rising house prices will help to offset the increasing ‘loan’ and to potentially mitigate the effect on your estate.

Who would be responsible for the maintenance of my home?

Home reversion scheme: You would be legally required to maintain your home due to the fact that the reversion company takes a direct financial interest in the property (see ‘impact of rising house prices’). Therefore this is a less suitable option if you intend to use any of the money released to make home improvements.

Lifetime mortgage: There is typically a clause included as part of the loan agreement that states that you would need to keep your property in good order. Any increase in the value of your property, for example, through making home improvements, would benefit you (see ‘impact of rising house prices’).

Would entitlement to means-tested benefits be affected?

Home reversion scheme: Entitlement to means-tested benefits could be affected if the money released is retained as savings.

Lifetime mortgage: Entitlement to means-tested benefits could be affected if the money released is retained as savings or increases your income above the means tested limit.

Would there be any effect on inheritance tax (IHT)?

Home reversion scheme: A reversion scheme could reduce the potential amount of IHT due, since on your death, the part of the property sold would no longer be part of your estate.

Lifetime mortgage: A lifetime mortgage could reduce the potential amount of IHT due, as the ‘loan’ taken out on your home would be off set against the value of your estate thereby reducing it.

Would I still be able to leave an inheritance?

Home reversion scheme: If you have sold your entire home to the reversion company, it would not be possible to leave any inheritance from it. If you only sell part of your property you would guarantee an inheritance on the unsold portion.

Lifetime mortgage: There would be the potential to leave some inheritance, as long as the debt (plus the interest accrued) does not match or exceed the property’s value.

However, we always recommend that people only consider lifetime mortgages with a ‘no negative equity’ guarantee (that is, you will never owe more than the value of the property).

Peter Fisher is director at Help The Aged Equity Release Service. He can be contacted on 01865 733009. Website: www.helptheaged.org.uk/equityrelease