It might surprise people, but homeowners could be financially better off with a drawdown lifetime mortgage than they are through downsizing over a 15-year period – the typical length of a lifetime mortgage.
This challenges the commonly-held view that downsizing should be the only option to consider when raising funds in later life.
There’s still a lot that people don’t know
It is often suggested that the total amount to be repaid on lifetime mortgages doubles every 10 years. However, this is not always true in today’s marketplace.
For the statement to be true, the interest rate payable on the plan must be 7.2% or higher. This is down to something called the ‘rule of 72’.
In this case, 72 is divided by the interest rate payable to calculate the time taken for the amount to be repaid to double with a lifetime mortgage.
In reality, there are now many plans with interest rates below 4%. For example, Pure Retirement’s Classic Drawdown Lite Plan currently offers an Annual Percentage Rate (APR) of just 3.86%.
With this plan, it would take 19 years for the amount to be repaid to double.
Rising house prices can offset compounding interest
The positive effect of rising house prices, combined with low fixed interest rates for life, is rarely discussed. However, these factors can significantly impact the total amount to be repaid on a lifetime mortgage over time.
The ‘rule of 72’ which I explained above, takes into account the effect of compound interest when applied to a lifetime mortgage. This is where the interest repayable is added to the amount borrowed and most lenders apply this annually. So, if you borrowed £50,000 (and using the plan above), it would take 19 years before you had to repay £100,000 in total.
While obviously house prices do fluctuate, history shows us that over time they have only risen. The Nationwide’s House Price Index started in 1952 and since then house prices have only fallen for a total of 3 of those years – primarily during our domestic recession of the early 1990s and the global recession of 2008. If the value of your home rises annually, then this could dramatically offset and practically reduce the final amount to be repaid with a lifetime mortgage.
An example: Lifetime mortgage vs downsizing
By using the drawdown features of a lifetime mortgage, it can be more financially beneficial to use a lifetime mortgage to raise funds, rather than downsizing.
For example. A 70-year-old owner of a £350,000 property takes out a £100,000 lifetime mortgage using the Pure Retirement Classic Drawdown Lite lifetime mortgage at 3.74% MER (3.86% typical APR). MER is the interest rate payable if you were to repay the interest accruing on a lifetime mortgage every month for the duration of the plan.
They borrow £64,000 now, and the remaining £36,000 five years later. The final amount to be repaid after 15 years is £167,560.
Over this time, the annual house price has increased 3.2%*. When the plan is repaid, the house is worth £561,388. Including the costs associated with taking out a lifetime mortgage, an estate of £391,788 remains.
The same person instead decides to sell their £350,000 home and downsize to a £250,000 property (again raising £100,000). After 15 years, the house would be worth £392,227 (including all the costs associated with moving – such as Stamp Duty).
A final calculation shows that the homeowner is just £489 better off downsizing than taking out a drawdown lifetime mortgage – over a 15-year period. Or £32.60 a year.
If we apply the average annual house price inflation over the last 45 years* to this example (7.8% HPI), then the benefit of a drawdown lifetime mortgage over time is staggering.
In this example, the homeowner would be £147,683 better off with a drawdown lifetime mortgage, as opposed to downsizing.
Staying savvy in later life
The lifetime mortgage market has changed dramatically over the last few years and plans now offer a wide range of flexible features and very competitive fixed interest rates for life.
For many people, it is simply no longer true that the only option to raise funds in later life is to sell the family home and downsize.
People don’t just want to sell the home they have lived in for many years, the home that they may have brought their children up in, the home that is close to their friends and their support network.
To provide a fair view of lifetime mortgages, we need to make sure the public are aware of all possible avenues.
* Figures from Nationwide’s House Price Index, Q 2018
Mark Gregory is the founder of Equity Release Supermarket. Over the years, he has built a strong network of financial advisers across the width and breadth of the country, many of which have experience with leading equity release companies such as Aviva and Prudential.
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