Rising house prices makes equity release attractive but there are costs, warns Jeff Salway
The number of people seeking to boost their retirement finances by using equity release loans to unlock the cash tied up in their property has reached a new high, despite ongoing concerns over the risks involved.
Take-up of the schemes has soared in recent months as house prices have risen and low interests rates have continued to erode savings pots.
The most common form of equity release is a lifetime mortgage, where those aged 55 or over can take out a loan against their home. The loan and the interest is typically repaid with the proceeds of the eventual sale. There are other options available, but there are concerns that the market has been slow to evolve with the needs of retirees.
More than £384 million was taken out in equity release loans in the three months to the end of June, the Equity Release Council recently revealed, the highest amount since records began in 2002.
Demand has grown markedly north of the Border. Households in Scotland took out 843 equity release plans in the first half of 2015, up from 718 a year earlier, according to specialist adviser Key Retirement Solutions.
The surge is due to a combination of reasons, including higher property prices and the disproportionate impact of low interest rates on retiree incomes. Suggestions that the pension ‘freedoms’ which came into force in April would dampen demand have proved wide of the mark. Instead many experts believe equity release could become even more popular as people turn to it later in retirement having prematurely drained their pension pots.
The recent increase has also been driven by the demise of interest-only mortgages and the tightening of affordability rules since the mortgage market review (MMR) took effect in April 2014. The City regulator has estimated that some eight in ten borrowers with interest-only loans maturing over the next decade have no repayment plan and so could be saddled with mortgage debts in retirement.
“Lenders aren’t willing to offer over 65s a ‘high Street’ mortgage, while many people don’t have the income required to support a normal loan and have become mortgage prisoners,” said Alison Mitchell, mortgage expert at Robson Macintosh. “So equity release, if done properly, has proved a lifeline for many.”
But anyone considering this option needs to tread very carefully, and for several reasons. One is the cost, as the interest charges can mount up alarmingly over time. Rates typically range from 5.3 per cent to 6.5 per cent, but some are significantly higher and the compounding effect on the interest means the loan can often double over ten to 12 years.
“If you can pay the interest each month, then the plan works just like an interest only mortgage which expires on death and is not age restricted,” said Mitchell. “If you can’t cover the cost, then you risk eating away all the equity in their home.”
This can be a particular issue if the property is being left as a legacy, said Scott Pentleton, director at Edinburgh-based IFA Alpha Wealth.
While most borrowers understand this, he said, many overlook the possibility that they may need to move home again in the future.
“Although at the application stage most are fit and healthy and have no desire to downsize from the family home, consideration should be given to stairs, maintaining gardens & heating costs,” he explained.
“In time these may be harder to deal with and should property prices stagnate or rise slowly, then it will have a detrimental effect on future purchasing power.”
There are also steep repayment fees to factor in, with some lenders charging as much as 20 to 25 per cent of the amount released. Costs can vary between different types of plan. Lump sum “roll-up” plans are no longer the norm, with drawdown arrangements - where borrowers can access just a portion of their equity – and deals where the borrower avoids the roll-up by paying interest each month becoming more popular.
But more flexible options are needed to meet borrower needs, said Pentleton. “A product that would allow a fixed regular income, or combination of lump sum and fixed income, would allow debt to accrue slower and would almost certainly help meet long-term demand.”