Equity release earned itself a well deserved reputation as a dangerous rip-off product in the late 80s and early 90s. Most people still hold this view of equity release or at least remember the scandals (if you don’t remember then you are probably far too young to be reading a blog about financial services!) and view it with extreme scepticism. A lot has changed since then but has it made a difference and does equity release now deserve to be considered a legitimate option?
Before we get started, what is equity release?
Essentially, all equity release products are ways of getting cash from the value of your home without having to move out of it. There are actually different product types available including Lifetime Mortgages and Home Reversions with a number of different variations within those types. If you want a more in-depth guide then you could do worse than to look at the Financial Services Authority’s (FSA) consumer website. There is a PDF guide to equity release on this page.
So why are we even talking about equity release?
Many people these days are approaching retirement or have retired capital-rich but income-poor. This is largely as a result of both rapidly rising house prices (combined with around 70% owner occupation in the UK) and inadequate personal and state pension provision. With increased life expectancy there is now a fear, and indeed a genuine risk, that we will outlive our financial reserves and have a vastly reduced quality of life during retirement.
It seems to me that viewing property as a pension is increasingly prevalent – just look at the boom we’ve had in buy-to-let over the last decade. And many people already use alternative means of releasing equity – borrowing money against their home, downsizing, selling up and renting instead – so there is no reluctance to make use of cash tied up in property, just a reluctance to use specific equity release schemes.
Equity release by any other name
I think there’s a lot more equity release around than people admit – we just have different names for it. If I increase the borrowing against my home by remortgaging with an interest only mortgage is that not equity release? Of course it is but I don’t need to go to a specialist equity release company to do it. There is more competition in the equity release market now than there was 5 years ago – Norwich Union, Northern Rock, Prudential and Scottish Widows have equity release products – but still nothing like a full range of big name providers.
Why are all the big players not in the market? It may be true to say that if all the household names offered the service it would help to overcome the public scepticism. However, there was a rather scathing report by consumer watchdog Which? that pulled no punches when criticising household name Norwich Union. So perhaps the reputational risk is perceived to outweigh the opportunity. The fact is that many household names offer equity release products but they are kind of under the radar.
Is the poor reputation still justified?
Steps have been taken to clean up the equity release market. A trade body, Safe Home Income Plans (SHIP), was launched in 1991 and is in their own words “dedicated entirely to the protection of planholders and promotion of safe home income and equity release plans”. All providers who sign up to SHIP offer certain guarantees. For example, you cannot lose your home – whatever happens to the stock market or to interest rates. And under their no negative equity guarantee you will never owe more than the value of your home. These protections do not exist for standard mortgages. But let’s be honest, who trusts self-regulated companies? Especially those that have misbehaved in the past.
The Financial Services Authority (FSA) took on responsibility for the regulation of mortgage lending, arranging, administration and advice on 31 October 2004 – including Lifetime Mortgages. On 6 April 2007, Home Reversion plans also became authorised. So now the general public have more protection than ever before and recourse to complain should anything go wrong sales volumes have shot up right? Well, no actually. They are on the increase but are still pretty small beer in comparison to the mortgage market generally.
Is it just too expensive to be considered fair?
I think this might be the root of the issue. On a variety of Lifetime Mortgage known as a Roll-up Mortgage you borrow a lump sum or arrange a drawdown facility. Interest is added to the loan on an annual or monthly basis but you do not pay the interest until your home is sold. This means that interest is charged on your interest and this compound interest effect quickly makes your loan quite large. I think people see this and are horrified at how much they eventually owe. The article by Which? that I mentioned above provides an example:
If a 60-year-old borrowed an £80,000 lump sum with a typical equity release lifetime mortgage, it could cost them £256,570 by the time they were aged 80, and £343,350 if they reached 85.
Well that’s just the effect of compound interest for you. Why are we horrified? Just think of it the other way around and imagine you deposited £80,000 in a high interest account. Why, after 25 years it could be worth…
Equity release is expensive – that’s not a criticism of the providers though, just a fact about compound interest and borrowing money over a long period of time. Still, we don’t like to think we’re getting a bad deal. Equity release is a last resort product for those people who really really don’t want to move home but have no other way to release cash to improve their lifestyle in retirement.
As my old high school English teacher said ‘don’t open a whole new can of worms in your closing paragraph!’… Which? also claimed equity release mortgages are advertised irresponsibly, citing Norwich Union’s suggestion that its scheme could pay for a trip to New York or ‘something for the family’. Illustrating this is the finding that the minimum £15,000 loan with Norwich Union would cost £28,000 after ten years’ time. I completely agree – advertising equity release as a way to fund a holiday is irresponsible. In my research for this article I’ve uncovered some interesting and rather scandalous practices going on in the US with equity release – they call it reverse mortgages – and I’m going to write something about that and other irresponsible/immoral practices next.