The perils of equity release – and how to avoid them
THEY have been described by former tennis star Andrew Castle as one of the ‘biggest scandals in this country’. But financial plans enabling elderly homeowners to take out a mortgage on their home without having to pay interest on it during their lifetime are growing in popularity. The Mail on Sunday look at the pros and cons of these equity release schemes.
What is an equity release plan? IT enables older property owners – over-55s – to borrow against the equity they have in their home. Many in their late 60s and 70s are equity rich but cash light. An equity release plan provides buyers with ready cash.
Typically, they pay no immediate interest on the money they borrow. Instead, interest is rolled up at a fixed rate, agreed at the outset. The outstanding loan is called in when the homeowner dies – and is typically repaid from the home’s sale. Hence the name often used for them – a lifetime mortgage.
Who offers these products?
THEY are sold by major insurance companies – usually through independent financial advisers who have passed special exams proving they can offer sound advice.
The biggest provider by far is Aviva. Other players include Hodge Life, Just Retirement, Partnership and new entrant Legal & General. Just Retirement and Partnership are currently in the middle of a merger. Firms that advise in this area include Age Partnership, Bower Retirement Services and Key Retirement.
So why does Andrew Castle believe they are a scandal?
IN June this year, he told The Mail on Sunday that companies peddling equity release were ‘taking advantage’ of the elderly.
He based this on the fact that his inlaws took out £70,000 of equity from their home via a lifetime mortgage, only to be required to pay back £118,000 five years later when they needed to move into a care home. The £48,000 cost was a mix of early redemption penalty and interest rolling up at six per cent. A complaint made to the Financial Ombudsman Service by Castle was not upheld.
Is he right or wrong?
EQUITY release is not a scandal – although it was back in the late 1980s when companies such as Fisher Prew Smith (long defunct) fleeced borrowers, and some lenders went on to chase their children to clear outstanding debts after their parents died. Now, the vast majority of equity release plans come with a nonegative equity guarantee which means that if the eventual mortgage debt exceeds the value of the home, the provider cannot chase anyone for the shortfall. They take the hit. There are also strict rules governing the information providers must include in the literature given to prospective buyers – for example, costs. Financial advisers must also encourage buyers to discuss any plan with their children.
Where Castle is right is on the cost of equity release. It is expensive. Interest rates are higher than on a conventional mortgage. Take the example of a couple – man aged 75, woman 73 – who are both in good health and are looking for a £95,000 lifetime mortgage from a home valued at £250,000. Aviva says it would charge such a couple a fixed interest rate of 6.79 per cent. The £95,000 debt would grow to £131,940 after five years and have nearly doubled after ten (£183,244).
Assuming no rise in the value of the couple’s home, the no-negative equity guarantee would be triggered after 15 years. Is there any way of reducing the cost of equity release? SHOPPING around is essential because insurers levy different interest rates. An adviser will do this for you. According to Age Partnership, the average interest rate for a lifetime mortgage taken out last month was 5.82 per cent, a seven-year low.
One way to reduce costs is by not taking all the mortgage in one go but drawing down on it as and when money is needed. By doing this, less interest rolls up.
This is what 67-year- old Gwen Wilson, a part-time supermarket assistant from York, has done. She took out a lifetime mortgage with Just Retirement three years ago after seeking advice from Bower Retirement Services.
Although she was granted a mortgage of £48,500 on her three bedroom semi-detached house valued at £175,000, she initially took only £32,000 which meant interest costs rolled up on this sum only.
She has since made two further withdrawals, leaving her with a remaining £4,000 to draw down when she wants to. So far, her mortgage debt has grown to £48,300.
Gwen, who is divorced, has used the money to make home improvements and have her garden landscaped. She says: ‘Of course I’m aware the outstanding loan will get bigger – and grow more quickly – as I get older. But I’m comfortable with it. All the improvements have helped boost the value of my home and my son Michael is happy with what I have done.’ Andrea Rozario, of Bower, says: ‘The impact of the compounding of interest on a lifetime mortgage can be powerful.
‘Illustrations of its effect are spelt out in documents that borrowers receive from the lender. ‘I do urge them to absorb such detail before signing on the dotted line.’