A rising number of homeowners are using equity release to clear mortgages and credit cards despite the risks, writes Jeff Salway.
SCOTS are using equity release mortgages to unlock cash from their homes in ever increasing numbers in a bid to ease their financial pressures. The popularity of the loans is set to reach new highs as interest-only mortgage prisoners search for an escape from their predicament.
Eight in ten borrowers with interest-only loans maturing over the next decade have no repayment plan and risk entering retirement with mortgage debts, the Financial Services Authority (FSA) estimates.
One of the solutions available to older homeowners is equity release – and its popularity is set to soar as a result.
The dangers associated with equity release, which allows homeowners to access the equity tied up in their property, have been well documented. Yet more Scottish households than ever are taking out the mortgages.
More than 270 equity release plans were sold in Scotland in the three months to the end of September, according to Key Retirement Solutions (KRS). They were used to unlock housing equity worth a total of £11.3 million, up 65 per cent on the same period last year.
The growing popularity of the product, available to those aged 55 and over, reflects the money pressures faced by older households. With life expectancy climbing, the cost of living rising, savings incomes squeezed, pension investments under-performing and annuity rates on the slide, many people near or in retirement are under the financial cosh.
Around one in five Scots taking out equity release plans in the last quarter used some or all of the money to clear their mortgages, while the number going into equity release to repay unsecured debts such as credit cards soared by almost a fifth.
And now the interest-only time-bomb is set to drive demand for equity release even higher still.
More than one in four outstanding mortgages is on an interest-only basis and many – including three-quarters of those taken out in 2007 – have no repayment plan in place.
Borrowers who had relied on house price rises to help them repay the capital have been hit by the property market slump, while some lenders will no longer accept cash savings as a repayment vehicle.
That has left thousands of borrowers in Scotland with a loan they can’t repay and unable to secure an alternative mortgage.
“This is a scenario financial advisers are seeing more and more each week,” said Alison Mitchell, mortgage expert at Robson Macintosh, an Edinburgh-based IFA.
“Many over-55s, a generation predominantly linked with endowment mortgages, are faced with the realisation that they need to find thousands of pounds once their mortgage term expires.”
This is where equity release comes into play, particularly with downsizing being unrealistic for many homeowners in the current subdued market.
There are two types of equity release product: home reversion schemes and lifetime mortgages. The most popular is the latter, where a loan is taken out against the home as either a lump sum, regular payments or a combination of the two. The interest is usually fixed, rolled up and added to the initial amount. The loan is usually paid off with the proceeds of the eventual property sale, often after the homeowner’s death.
“This isn’t a one-size-fits-all solution and proper sound advice needs to be sought, but if it does suit, it’s a great way to meet the lender’s demands for repayment,” said Mitchell.
One option of particular appeal to interest-only borrowers is to take out a lifetime mortgage where the interest is paid on a monthly basis and not rolled up into the total loan, but this isn’t offered by many lenders.
“This is a great compromise for those stuck on interest-only mortgages,” said Mitchell. “It ensures that the interest element remains the same at all times and acts like a straightforward interest-only mortgage, without the requirement to repay at any time.”
Home reversion schemes differ in that the homeowner sells part of the equity in their property to the provider (for below the market value) but remains in their home indefinitely.
Equity release mortgages are generally more expensive than normal home loans, but the gap is narrowing.
Lifetime mortgages repayment rates tend to be around 6.5 per cent, but there are now some deals below 6 per cent, according to the website www.equityreleasesupermarket.co.uk.
Loans where the interest is paid each month rather than compounding are slightly more expensive, ranging from 6.4 to 7.3 per cent. Providers include equity release specialists Stonehaven, More2Life and Hodge Lifetime.
Greater competition in the market provides opportunities for equity release borrowers to switch to cheaper deals.
Watch out for early repayment charges, however, as these might erode any savings you make from switching. Some borrowers will negotiate on these, but where they are charged they can be significant.
There are also mortgage and equity release advice fees to take into account. That advice is well worth paying for, as there are real risks to equity release.
For example, the compounding effect means the mortgage debt can roll up rapidly, even doubling in some cases.
Fortunately, providers that belong to the Equity Release Council have no-negative- equity guarantees, where they promise that borrowers “will never owe more than the value of their home, and no debt will ever be left to the estate”.
An equity release loan may also affect benefit entitlements; make it harder for you to move home in future; and is likely to reduce or even wipe out the inheritance you can leave when you die.
Mitchell stressed the importance of taking advice in what can be a complex and risky area. “Borrowers need to be aware of all the implications: from the effect it could have on their benefits, if in receipt of them, to the implications it could have on their family if they are expecting some inheritance from the property,” Mitchell said.