So you work your whole life, paying the bills and at the end of it all, you get to retire, comfortable in the knowledge you now own your home. No more payments to make. £200k is sitting there, locked in bricks and mortar while you now struggle by on your state pension. The dreams you had for your retirement stay just that.
Bit dramatic? Maybe not, studies have found that’s how it is for a significant portion of those retiring each year. Really, it requires no studies, I am sure most of us know many in this type of situation.
Now you could mistake this so far as an advert for equity release, not so. The basic concept of equity release is that you have wants and needs without the cash to turn them into a reality. That may mean your wants and needs can only become a reality by using the equity stored in your home.
In the past, the option you had was simple enough, sell your £200k home, buy a smaller £100k one and then use the balance to fund your wants and needs, at the very least make your retirement that bit more comfortable. That is easier said than done.
Once you get to retirement, the last thing on your mind may be moving. For some, downsizing could mean a move away from your friends, family and the area you are familiar with.
And that brings us to the option of equity release. Giving you the ability to stay in your home while at the same time being able to free up some of the equity and achieve those wants and needs you had anticipated being able to do in retirement.
That is what we are going to look at here, the products, the pros, cons, and pitfalls.
This is going to be a guided overview of equity release, broken down into a number of articles. This is a heavily regulated type of product and I cannot stress enough the need to seek professional advice, for that reason I am going to keep this quite a high level rather than trying to cover the detail.
A lifetime mortgage is perhaps the simplest form of releasing equity from a property. There are several ways to benefit from the equity in a home, I will look at them all in this set of articles. First, let’s take a look at the common elements of lifetime mortgages.
Lifetime mortgages come in a few different forms, which are most suitable depending on individual circumstances. We will look at four options in the next articles.
The amount borrowed is only ever repayable if one of these five events takes place.
- Moving to a new home
- Moving into permanent residential care
- Repaying the loan
- Death of the sole applicant or both if joint applicants
- The lender exercises its legal right to take possession
It is worth noting that at this point you will always own your home with a lifetime mortgage. Ultimately it is a mortgage like any other, you borrow an amount and it needs to be repaid at some time in the future, interest is payable and your home may be at risk if you do not keep up interest payments if they are due.
Once the facility ends and is repaid with interest, any equity left over is returned to you or your estate.
Now let’s take a look at some of the options to release equity using a lifetime mortgage.
With an interest-only product, there is a requirement to make interest payments each month. The amount paid is based on how much you borrow and the rate charged. Now some may initially think that their understanding was that no payments would ever need to be made. And we will get to that, but there are benefits to paying the interest but of course, it needs to be the right option for the applicant.
If an applicant borrows £100,000 at a rate of 3% then they will pay £3,000 in interest each year. Bear in mind that only the interest is being paid, the initial £100,000 borrowed will remain outstanding and payable in full at the end of the term, whenever that is. A lifetime mortgage does not have a set end date, it is based on a specific event occurring as noted previously.
By using this option, the full £100,000 is given to the applicant. No limitations or restrictions, it is their money to spend as and when they choose.
The key benefit gained here is that paying the interest each month means the amount borrowed will never increase. The applicant will only ever owe the lender £100,000.
So if the mortgage is held for 20 years and over that time the value has increased to £250,000 at the point of sale, the lender receives £100,000 and the applicant or in the case of death, their estate will receive the remaining £150,000. That remaining cash could then be distributed to children or other family members or however, the applicant chooses.
Rolled-up interest mortgages still take on the basic form of an interest-only mortgage. The difference is that the borrower will make no payments at all to the lender at any point over the life of the mortgage. Rolled up interest simply means that the interest still needs to be paid, but the lender will add it to the outstanding balance each month and it will be repaid when the mortgage ends.
Stick with the previous figures used, the borrower borrows £100,000, at a rate of 3%. As noted above, whilst the interest is still due, the lender will add it to the loan each month instead of asking the borrower to pay it.
It is important to understand that interest is compounded. What does that mean? Another example is needed. Let’s assume that the rate of interest never changes, it will always be 3% and the loan is completed on the 1st of January.
|Month||Starting Balance||Interest||Closing Balance|
So what is happening here is that each month the balance goes up as interest is added, however, as the balance increases due to the interest being added means that more interest is being paid with each month that passes. So the borrower is paying interest on the interest already charged, this is compounded interest.
With interest-only the interest will be £250 each month (assuming the interest rate never changes), regardless of how long the facility lasts and the borrower will only ever pay back £100,000.
Say the mortgage lasts 25 years, on a rolled-up basis, at the end of 25 years the amount owed will be £211,501 (again assumes no change to the interest rate). That is £100,000 originally borrowed and a further £111,501 in rolled-up interest.
Compare that on an interest-only basis where you make the interest payments monthly, the total interest charged is £75,000. £36,500 less than rolled-up interest.
The biggest benefit of this type of mortgage is that there will never be any payments made during the life of the mortgage. A £250 monthly saving compared to interest-only. As with interest-only, the borrower will receive the entire amount of £100,000 in a single payment to use and when required, there are no restrictions on how it can be spent.
Now the apparent downside which could be a benefit here is that when the time comes to repay the mortgage, the loan and all the compounded interest will need to be repaid, from our example above that would be £211,501.
Suppose again the property is valued at £250,000 at the point of sale. This means just under £40,000 will be returned to the borrower or estate compared to £150,000 had the interest been paid monthly.
This is really where the right option needs to be considered. If the borrower has nobody to leave a cash surplus to in the future, there is no reason to be particularly concerned about what is leftover in future years. So what would be the point in paying the interest on a mortgage when the borrower has nobody they want to leave money to?
Drawdown mortgages are a more flexible way of releasing equity from a home. There are a lot of benefits to this plan. They are for those who want to have cash available and ready when needed but have no requirement for the entire lump sum sitting in a bank account doing little and let’s face it, certainly in 2020 earning virtually no interest.
Essentially what happens with a drawdown facility is that the borrower agrees an amount to be lent, we will stick with £100,000 as with previous articles.
The borrower does not receive all of the £100,000 in one go. It is however available to draw as needed. So, on completion, the borrower may opt to take £10,000 to cover needs for the first year, then a further £5,000 in year two and so on.
Some lenders will set a minimum amount that can be drawn and a maximum number of withdrawals in each year.
No payments are made at all, the interest on drawdown mortgages is rolled-up. See more on that here.
Only what has been drawn will have interest applied each month and added to the balance. So unlike previous facilities discussed, a lot of interest can be saved by drawing equity this way as the amount is drawn will build up over time.
It is worth noting that whilst interest is rolling up and the balance increases, the addition of interest does not reduce the amount which can be drawn. If the borrower agreed on a loan of £100,000 then they can draw up to that amount regardless of the interest already applied.
This type of facility could be most useful to those who want the ability to have extra money available as and when needed. This provides comfort to the borrower that it is there but they may also want a way to preserve as much equity as they can to pass on to children in the future. This provides a good opportunity to do that.
In the previous few articles, we looked at mortgages where a borrower would receive either a one-off lump sum or have the availability to draw more flexibly as required. In the last option, we will look at the ability to receive an income from an equity release.
The ultimate goal then is to provide the borrower with an income for life.
Again, best explained in a couple of parts.
A home income plan starts out as an interest-only mortgage. There is no option to roll up the interest here, it must be paid each month.
Again, I am assuming a borrower receiving £100,000 from the equity release.
The £100,000 will be released in a single payment. The difference here is that the borrower will not receive any of it.
With lender support the money will be used to purchase an annuity, this is a retirement product that is guaranteed to pay the borrower a certain amount each month for the rest of their life.
Annuities are complex products, in essence, the annuity provider will assess the borrower, the amount being invested (£100,000) and provide a figure that will be paid to the borrower each month until they die. Although it is not that simple in reality. There are many factors to be considered.
An annuity from a provider's point of view is a gamble. They need to determine based on the amount invested, the borrower’s age, health and so on, how long they anticipate having to make the payments. The longer they believe the payments will need to be made the lower the payment will be. There are also options that allow a beneficiary, a husband or wife, for example, to continue receiving payments for their life after the borrower dies. This will also result in lower payments being received.
Annuities can be risky, in the event of a borrower taking out an annuity and then dying within a much shorter period of time than expected, the annuity provider may not have to return any of the money even if the borrower did not actually receive much of it payments before death.
As the mortgage is interest-only where interest payments are required to be made each month, it only makes sense to choose a home income plan as a possible option if the amount received each month is enough to cover the interest payments and leave enough left over that it can be used for whatever purpose it is intended.
At this point in 2020, a Home Income Plan is not a popular choice. The reason for that is due to equity rates falling so much in recent years. I can say from running quotes for clients that in many cases the return barely covers the interest with nothing left for the client. At today’s rates, the amount you need to invest must be significant to get sensible returns making it worthwhile.
Of course, that can and will change over time.
There are many positives to equity release, unfairly it has been reported in the press as a “trap” or “only good for lenders”. But the fact is we are living longer and for many the only way of financing that longer life is a state pension. The British way of life for a long time is to get married, have children and buy a house although not necessarily in that order.
The view was that in later years, you will sell the family home and get something smaller, hopefully benefitting from the equity left over to make retirement more comfortable. But with the way things are today even downsizing is costly and of course, children are staying at home longer due to the challenges of getting on the property ladder.
What if you can retire and get something back from that home you spent a sizeable portion of your working life paying off and you don’t have to pay it back or move? Hello, equity release and lifetime mortgages!
Any finance against your property is a big decision later in life, so it’s not something you enter into without a lot of thought so always seek guidance from a reputable provider.
An example of what many have gained from releasing equity.
- Buying a mortgage-free property abroad.
- Assisting children with deposits for their own homes.
- Providing a better income throughout retirement.
- Home Improvements.
- Paying off debts.
The list goes on. Equity release opens up opportunities that were not possible for pensioners in the past.
Nothing in life is free of risk, whilst equity release can bring many benefits you must always weigh up the risk with the reward. Let’s take a look at some points.
One of the most common questions asked is who owns the property when a lifetime mortgage is taken out? The client does, always. A lifetime mortgage is a mortgage like any other. An amount is agreed and the lender takes a charge of the property. Nothing unusual or different than taking out a standard mortgage.
Let’s look at other questions that come up.
Absolutely, once the property is sold and the lender has been paid, anything left comes straight back to the client or in the event of their death, their estate receives the surplus.
Equity release in the UK has an industry body called the Equity Release Council, Providing you select a lender who is a member they will offer a no negative equity guarantee meaning you will never be responsible for the balance should the property not sell for enough to cover the debt outstanding.
In general no, however, there are of course circumstances where it could happen.
If your facility requires you to make interest payments the lender could apply for possession if you default on enough payments.
You have a responsibility to maintain the property to a reasonable standard, fail to do so and it impacts the property value the lender could apply for possession.
Yes, however, bear in mind that this is a lifetime mortgage, paying it off early can result in a significant early repayment charge (ERC). You will have been given an indication of how much that may be at the time of application. If you suspect there may be an opportunity to repay early at the time of application let your lender know, that there are flexible options that may reduce the charges.
Your state pension is yours regardless of any other assets you have. However, many benefits are given depending on your financial status. If you come into a large sum of money as a result of equity release you may lose existing benefits as you are now deemed capable of covering the costs on your own.
When dealing with such an important financial arrangement there has to be regulation around it right? Indeed, there are three important bodies to consider when it comes to ensuring lifetime mortgage lending is managed correctly.
All advisers and providers of lifetime mortgages are regulated by the FCA. This is the principal government-controlled body responsible for oversight of Lifetime Mortgages. They set the minimum standards that all advisers and providers must work within.
The ERC is a voluntary trade body that most providers are a member. They aim to maintain high standards of advice and service in the lifetime mortgage sector. Providers sign up to a voluntary set of rules and principles. These are generally more beneficial for the client than the FCA rules and guidelines.
It is important to bear in mind however that the ERC has no legal recourse over its members should they not maintain the high standards expected. At best they could remove their membership.
There are benefits to using a provider that has ERC membership, one would be that it is only the ERC that ensures their members will not pursue you in the future for any shortfall as a result of negative equity. This is binding and stated in your offer documents. The FCA simply states that a provider must explain in their illustration how they handle negative equity, not that they cannot pursue it.
The Financial Ombudsman is not a regulator, however, when things go wrong as they sometimes can, you need someone to turn to. If you complain to your provider and you feel they have not dealt with your complaint adequately you can take the matter to the ombudsman. They are dubbed as the UK’s official experts in sorting out problems with financial services.
They provide an unbiased view and if they rule that someone has been treated unfairly, have legal powers to ensure it is put right.
By this point, you will have a basic understanding of equity release in relation to lifetime mortgages. There is a lot to consider and depending on the client's circumstance, a whole lot more. Many will struggle to come to terms with the idea of ‘giving up a home’, even though that is not the case as you still own it and have the right to live in it until a specific outcome occurs. There are psychological barriers, I have seen them.
The Financial Ombudsman receives many complaints from the family of those who have taken out a lifetime mortgage, especially children. They feel that a parent was vulnerable when signing up for the facility or knew about it but are shocked when they see the amount to be repaid.
Whilst it is considered beneficial for parents to discuss their intentions with children, there is, of course, no obligation for them to do so. Many parents never discuss financial matters with their children, why should this be any different? The crux of it is that children have an expectation their parents will have paid off the mortgage by the time they die and the property will be a part of their inheritance.
Despite the above, the Financial Ombudsman reported no widespread concerns around advice given. It would be true to say that lifetime mortgages are one of the most heavily regulated products on the market today.
Even once an agreement has been reached to provide a lifetime mortgage the client must seek independent legal advice before it can be finalised. This involves the client having a face to face meeting with a solicitor of their choice. This ensures that someone not connected to the process explains what they are taking on, the risks and so on. Only after that has happened can it then complete.
So whilst it certainly is a significant life decision to make, I personally believe it is a part of the industry that can be life-changing for clients, in a good way. Although not without risk, the regulation and processes designed are heavily in favour of the client, not the provider which means people can gain some comfort that they are in good hands should they decide to even take a look at releasing equity from their property.