Equity Release

2004
(by Graeme Young)

As house prices in Tayside and elsewhere in the UK continue to show steady and significant growth, the homes of retired people now account for one of largest pools of privately held wealth anywhere in the country.  With the population continuing to grey and the pensions sector still afflicted by uncertainty and a lack of customer confidence, equity release is becoming one of the most appealing and prominent means of funding retirement.

It must be acknowledged that the equity release sector still suffers from the hangover of bad publicity which accompanied the collapse in property prices, in particular in the South of the England, from 1988 to 1993.

In order to tackle this image problem, the vast majority of equity release lenders now offer negative equity guarantees. This means that the cost of the loan plus the interest at the date of death of the planholder will not exceed the value of the property.

However, it is important to distinguish between the two main types of schemes, namely reversionary and lifetime mortgages.

Reversion schemes allow homeowners to sell a share of the property in exchange for a lump sum on completion.  However, this amount is heavily discounted to reflect the fact that the sum is paid immediately to the owner, but the plan provider will not receive their share of the sale proceeds, until the property is sold on the earlier of the move to residential care or death.

However, during this time period, the plan provider will benefit from any increase in house prices between completion and final sale.

As an example, if the house value rises by 50% from £100,000 to £150,000 between outset and the planholder's death, the provider's share of 75% reversion will increase in value from £75,000 to £112,500 with the balance of £37,500 being passed to the homeowner's estate.

When considering this kind of scheme, a homeowner who adopts a reversion plan needs to live longer than the provider's assumption to gain the maximum benefit from the scheme.

Lifetime mortgages are no different from standard mortgages except the interest charged on the loan is not paid throughout the borrower's lifetime, but is simply added to the outstanding debt.  The total amount outstanding is then repaid when the property is sold or if earlier, the borrower moves to residential care.

The rates of interest chargeable can be either fixed or variable, but considering the arrangement is for life it would be prudent to consider either fixed rate or one that is capped at a known level.

The actual rates charged will be as much as 2 to 3% points greater than standard mortgages to reflect the fact that the lender is not receiving any repayments of either capital or interest during the life of the loan, which makes it more expensive to service.

Unlike reversion schemes, the provider has no share in any potential increase in the price of the property.  Homeowners rely on the property being worth more when they die than when the scheme started, so the rolled up interest on the home loan can be paid for from the proceeds, with a significant amount being left for their beneficiaries.

However, as detailed previously, the majority of providers of lifetime mortgages offer a negative equity guarantee to cover a situation where due to a decline in prices, or a stagnant market, the total debt exceeds the value.

If this should occur, then it is the provider and not the homeowner who pays the difference.

There can be implications for taxation if such plans are adopted and in particular if options are selected which produce income as opposed to capital.  The production of extra income can have an impact on the benefit of the minimum income guarantee (now pension credit) or the income tax age allowance.  Therefore, it is important to take advice, as to the suitability of such plans.

However, the impact of taxation may not all be negative.  The creation of a debt against the homeowner's estate, will reduce the total estate for IHT purposes and therefore, may reduce any inheritance payable.

In short, the equity release market has changed and matured greatly in recent years.

As life expectancy increases and with many people facing a shortfall in pension income, this method of funding a comfortable retirement should be strongly considered.