Your property is more than just a home, it is also the biggest asset you are ever likely to own.
There might come a time in your life when you need to cash in on that asset. As we all live longer, and the pension system lurches from one crisis to the next, unlocking the spare capital in our homes is likely to become an increasingly common way of funding retirement.
One way of doing this is to take out an equity release scheme. This financial services product allows you to borrow a lump sum or regular income against your property to spend on whatever you like home improvements, a new car or a holiday, or daily living costs.
You don’t have to sell your home, but can keep living there exactly as before, as can your spouse or partner after you die. You are also free to sell up and move to another property.
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The equity release company gets its money in the end, by clawing back what you owe from the proceeds of the property sale when you die or move into long-term care.
Most people recoil against the idea of selling off chunks of their property, but if you are strapped for cash in retirement, this might be the only way to make ends meet.
And increasingly, we will be strapped. The average pensioner earns just over £12,000, barely half the national average wage, according to insurer Prudential. One in four rely solely on the basic state pension of £4,381 a year. Yet spiralling house prices means that many are living in properties worth hundreds of thousands of pounds. Equity release schemes aim to square this circle, and are rapidly rising in popularity.
Some £1 billion are sold every year and that could treble to £3 billion in just three years, according to Datamonitor.
Bridgewater Equity Release, Ecclesiastical Life, Hodge Equity Release and Home & Capital Trust originally led the market, but now bigger names are getting stuck in, notably Northern Rock and Norwich Union. More recent big-name entrants include Bristol & West, Prudential and Standard Life Bank.
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But some of the biggest names view equity release with caution, including Barclays, Halifax, Lloyds TSB and Nationwide. Some fear equity release could trigger the next great financial services mis-selling scandal. So should you take the plunge?
There are two main types of plan. Which suits you better depends on your personal circumstances.
Lifetime mortgages
This is effectively an interest-only mortgage secured on your property. The interest rolls up and is repaid, with the original capital, when your property is finally sold.
You can’t borrow the full value of your home, only a percentage, based on how old you are. Northern Rock, for example, allows you to borrow up to 20 per cent of your property’s value at age 60, then 1 per cent more for each birthday. So an 80-year old could borrow a maximum 40 per cent.
Plans typically rule out younger borrowers, by setting minimum age limit of 55 or 60. At those relatively young ages, the numbers simply don’t add up.
The longer you live after taking out the mortgage, the more your estate will ultimately repay in compound interest. Take a 70-year old man borrowing £50,000 against a property valued at £250,000, using a 6.3 per cent fixed-rate lifetime mortgage from Norwich Union. By age 80, that original £50,000 would have rolled up up to £92,000 and by 85 to £125,000.
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You could end up owing quite a hefty sum, but Brendan Kearns, group proposition development manager at Norwich Union, notes that his property will also have risen in value. “If house prices rise 3% a year, his home would be worth an extra £62,000 by age 85, which still leaves £187,000 worth of equity.”
You don’t need all the money immediately, consider choosing a plan with a cash reserve, or drawdown. That way you only pay interest on the money as you spend it. A handful of lenders, notably Northern Rock, will pay monthly income instead.
Most plans allow you to choose between a fixed and variable interest rate, says Dean Mirfin, business development director at specialist equity release IFAs Key Retirement Solutions. “You could have this mortgage for a long time, and most people prefer the security of a fixed rate.”
Plans typically allow you to pay off your loan, early, but you face hefty early repayment charges in the first five years.
Industry group Safe Home Income Plans (SHIP) insists all 21 members offer a “no negative equity” guarantee, which pledges you can never owe more than the sale value of your home, no matter how long you live. SHIP also insists member can only accept business from an adviser with a qualification in lifetime mortgages.
Home reversion plans
These plans have a much lower profile, but might suit some people better, depending on their circumstances.
BPT Bridgewater, Home & Capital and and Partnership Home Loans specialise in home reversion plans, while Hodge and Norwich Union offer both types of plan.
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You sell the company a percentage of your property and are handed a lifetime lease, which allows you to live rent-free in your home, but as a tenant rather than owner. When you die, the percentage you sold “reverts” to the company.
You won’t receive the full value of the share you sell but a percentage based on age. A 70-year old raising money on the full value of their £100,000 house might get, say, £40,000. If selling a half share, they may get £20,000. The older you are, the more you get, as your life expectancy is shorter. Many schemes guarantee that if you die shortly after taking out a policy, some of the value you sold will be returned to your estate.
Dean Mirfin says home reversion may appeal to somebody with no dependants or little desire to leave an inheritance, because they can raise maximum cash by selling the full stake in their property.
Conversely, they may also appeal to somebody who wants to guarantee an inheritance. “If you sell, say, 50 per cent of your property, the remaining 50 per cent is guaranteed for your beneficiaries. You don’t get that certainty with a lifetime mortgage.”
If property values soar, however, that 50 per cent stake you sold could be worth rather a lot. That’s the chance you take.
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Currently, lifetime mortgages are regulated by City watchdog the Financial Services Authority (FSA), but home reversion plans are not. That changes from 6 April, when home reversion comes under FSA regulation, giving you greater peace of mind. For even greater security, look for a SHIP member.
The alternatives
But is equity release something you really want to do? There is a cheaper and safer alternative and it’s been around for years selling your property and trading down to something smaller.
A recent number crunching exercise by the FSA’s Financial Services Consumer Panel (FSCP) found that somebody looking to release £50,000 from a £250,000 property could be a massive £150,000 worse off after 20 years if they chose a home reversion plan instead of trading down. And a lifetime mortgage was £50,000 more expensive.
Unfortunately, IFAs aren’t obliged to tell customers that downsizing is likely to be the cheapest option, says FSCP chairman John Howard. “Many people see their property as a potential source of income as they get older but equity release deals often don’t look like good value.”
This echoes previous warnings from Which? that schemes can be “expensive, inflexible and leave you with little or no equity in your home, severely limiting your choices later on in life”.
Neil Thomas, director of IFAs Simpsons of Brighton, always tells his clients to consider trading down first. “We also examine ways of boosting their income by claiming their full state benefits or asking if family members can help. That solves the problem for most peop
le.”
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Of course, many elderly people are reluctant to sell up, having become emotionally attached to their home. You should also think carefully before handing over any equity sharing your property to family members, as things could turn nasty and put your home at risk.
You can buy equity release schemes direct direct from some companies, such as Norwich Union, but should always take independent financial advice. Choose a specialist, the FSA recently warned that many IFAs who carry out low volumes of lifetime mortgage business operate to unacceptably poor standards. Look for an adviser who has a Certificate in Lifetime Mortgages.
Equity release is a complex decision, for example, if you claim state benefits, your equity release pay out could hit your entitlement. Your age, state of health, tax position, savings, property value and family relationships will also affect your conclusions. Consult every key family member and beneficiary and a trusted accountant or solicitor.
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