Is switching equity release schemes a viable option?

Equity release has become synonymous with people over age 55 enhancing their retirement by helping release tax free cash from their homes. Where home improvements are needed, debt repayment necessary or assisting the children financially, equity release schemes have provided a solution for many retirees.

However, those people who have taken equity release in the past may find their existing scheme uncompetitive, or unable to meet their future needs. This article helps explain why existing plans should always be reviewed and covers the pros and cons of switching equity release schemes.

Firstly, how does equity release work?

Property ownership over the decades has proved a valuable investment vehicle. For people over age 55, equity release is a form of mortgage which allows this accumulated wealth to be withdrawn, and spent as one wishes.

The most popular form of equity release plan is the lifetime mortgage, where the amount released is calculated based on age and property value. For example, a single person aged 65 could release up to 30 per cent of property valuation. Once released, the lump sum attracts interest which is charged by the lender. Opting to repay this interest, or not, will then determine the future balance of the scheme.

Equity release schemes run for the rest of the person’s life and eventually repaid with the property being sold on death, or the last survivor moving into long-term care. Any balance remaining is then divided amongst the beneficiaries in accordance with the person’s will.

Reasons to consider remortgaging an equity release plan

These could be for any one, or combination of the following:-

To obtain a lower interest rate – by transferring and lowering the interest rate means less interest will be charged over the long term. Any reduction in interest can have a dramatic effect on the future balance on any roll-up lifetime mortgage scheme. This is due to the compounding effect taking less of a hold. Any reduction in the future balance will not only help increase the beneficiary’s inheritance, but also the plan holders could benefit from further equity being made available in the future.

To raise extra capital – this tends to be the most common reason to switch plans. Where equity release was originally perceived to be a ‘one-off’ transaction, many people had underestimated their future financial needs. Therefore, should the original funds be exhausted, there may now be further need for additional capital. The question then is whether to stay with the original lender, or look elsewhere for a better deal. It could even be the case that with some older equity release lenders, such as Northern Rock, they no longer offer additional borrowing. Therefore, it could be necessary to find a new home for the existing and further borrowings.

Additionally, in the meantime should an individual’s health have deteriorated, then an enhanced lifetime mortgage scheme could now offer a much larger amount than older equity release schemes. With providers using medical underwriting and actuarial calculations on life expectancy, these enhanced plans can allow for a greater lump sum if ill-health persists. In essence, the more severe the condition(s), the higher the maximum lump sum becomes.

To have a facility for repayment of the interest – older equity release schemes didn’t always have the option to repay some, or all of the interest. Newer plans from the likes of Hodge Lifetime, Stonehaven and more2life all offer the facility to repay the interest, without penalty, thus preventing any escalation in the future equity release balance. For some, having evidenced the yearly roll-up effect of interest on their annual statement, maybe enough is enough and they now wish to stop this interest building up. This could be achieved by switching to any of these new interest-only lifetime mortgage providers and repaying interest to keep the balance level, or lower, should partial repayments be selected.

Looking for greater flexibility – older equity release plans tended to offer a simple lump contract only. This meant retirees needed to estimate the lump sum needed in the future and then place this money into the bank. This wasn’t necessarily best practice. Holding these surplus funds in a bank account did not attract a greater interest than that being charged on the equity release plan.

Following the introduction of drawdown plans, a smaller initial amount can now be taken, leaving any unused funds in a cash reserve which can be ‘dipped’ into whenever required in the future. This is better housekeeping, as interest charged by the lender is based on the capital withdrawn, not the cash left in the facility. Taking the lifetime mortgage drawdown option could again result in a lower future balance for all.

Legacy equity release schemes

Equity release over the past 14 years has seen interest rates fall from their peak of over 8 per cent, down to today’s more competitive terms of less than 6 per cent. With the roll-up nature of the majority of schemes involving compound interest, under the right circumstances swapping to a newer lower rate could save many £1,000s.

Therefore, holders of legacy equity release schemes such as Northern Rock (now Papilio), Norwich Union (now Aviva), Portman Building Society, Mortgage Express, Prudential and others should consider a review of their plans. Just like people remortgage their residential loans for a better deal, so should equity release mortgagors. With many people carrying debt into retirement, remortgaging older equity release schemes in order to obtain a better deal is starting to become increasingly commonplace.

Points to consider

Evidently, there are many factors to check before transferring and it’s therefore essential an accurate analysis be undertaken by an experienced equity release adviser. Important steps need to be followed in order to assess whether a transfer is a viable proposition, or not.

First, we must look at the ceding scheme, i.e. the current scheme you are thinking of transferring from, to understand its features and ensure no benefits would be lost which could prove valuable in the future. This could be a feature such as Prudential’s Increasing Cash Reserve or even favourable fixed early repayment charges (ERCs) which could never be matched again.

Such early repayment charges are a main consideration before any transfer is conducted. It should be best practice that a redemption statement is obtained from the current provider to fully understand the nature and size of the potential charges. This will not only include the current balance and year-to-date interest, but also the daily rate of interest being added. This daily figure is important in calculating the potential redemption balance at completion stage, which may still be six to eight weeks away.

It is important to note that early repayment charges can fluctuate between the date of the initial analysis and completion. It is therefore vital an adviser checks this regularly during application stage to see whether the situation has changed. Liaison between adviser and solicitor is of paramount importance to ensure the penalty situation has not detrimentally changed prior to completion date, as this could adversely affect the benefit of any transfer.

There are three ways early repayment charges can be levied on lifetime mortgages; those linked to government gilts, long-term interest rates (SWAP rates) or on a fixed percentage basis. By changing from one ERC system to another should be fully explained, as moving from a plan with no penalty, to one where potentially a 25 per cent penalty exists based on the amount borrowed must be highlighted.

Next, we analyse factors which could affect the profitability of a transfer to the receiving scheme. This would involve establishing how much set up costs could be on the new plan. These costs and charges are: –

Valuation fee – based on the property value.

Application fee – charged by the equity release company.

Solicitors fees – necessary for the legals of the scheme to be implemented.

Advice fee – charged by your adviser.

Costs are a key factor in determining whether it would be prudent to transfer. The higher the set up fees, the longer it could take for the benefit of a lower interest rate to be felt. Standard set up fees taking into account all the above could amount to over £2,000.

However, some of these costs can be mitigated by sourcing the best equity release deals with brokers with availability to special incentives. For example, independent brokerage Equity Release Supermarket has access to the Aviva flex tool which can provide not only a competitive interest rate but also a free valuation and up to £1,000 cashback on completion. Deals such as this could prove extremely beneficial in offsetting the normal set up costs of a lifetime mortgage, thus making the transfer more cost effective.

Is now a good time to switch plans?

Equity release interest rates fell to their lowest rates ever in 2013. Since then we have evidenced a slight rate rise as longer term interest rates increase in the money markets. However, there is still time to secure a historically low interest rate which can then be fixed for life.

Following the 2014 budget announcement on annuities, equity release providers have yet to assess how a reduction in annuity sales could affect their future funding and how interest rates may be affected. With such uncertainty and should circumstances be favourable, now would be a sensible time as any to review your existing equity release plan.

The next steps

Independent advice from a qualified equity release adviser should always be sourced. To find a local equity release adviser contact the Unbiased website or the recognised trade body, the Equity Release Council.

Alternatively, a free switch plans calculator can be found online from useful websites such as CompareEquityRelease.com. Here you can conduct your own analysis to evidence whether any benefits could be made by switching equity release schemes.