Equity release schemes are set to become more popular in the next few years and advisers need to make sure they are up to speed on these products to make the most of future business opportunities, and avoid trouble.
The market for equity release schemes was worth £750m in 2001, according to research from Datamonitor, and the amount of equity in properties owned by the over-65 age group is estimated at £459bn, so the scope for growth in this market is enormous.
Any increase in the equity release sector is going to be driven by a number of factors, not least the increase in the number of people aged over 65. This is estimated to reach 9.6 million by 2006, according to the Office of National Statistics.
Another driver is the dwindling pension provision, evidence of which is the estimated £27bn pensions savings gap that is leaving older people asset rich and cash poor.
As a result, more people are likely to turn to equity release in later life to bridge the gap and make their retirement more comfortable. If advisers are not aware of how the plans work, and what the pitfalls are, they could be missing out on extra business and storing up trouble for themselves.
The current market
Home equity release is a scheme that allows an individual to unlock some or all of the equity in a property, while continuing to live there, and with no payments due until the property is sold when the individual dies, or they move into a care home.
There are two types of equity release schemes: home reversion loans, where part or all of the home is sold to a company, but the individual continues to live there until death. In a standard equity release mortgage the individual takes out what is essentially a mortgage on the home, but does not make any interest payments until the home is sold on death, or when they move into a care home in their old age.
Alison Cooley, of independent financial adviser Charcol, says: “For the equity release products, the maximum loan to value (LTV) ratios are based on the age of the applicant. Based on the products available, the mean average LTV ratio for 65-74 year olds is around 28% and around 39% for 75 and over, according to Datamonitor. So the amount, in terms of percentage of total property value, tends to be on average less than that withdrawn on home reversion schemes.
“The number of providers in the market is still comparatively low. Some providers have been rumoured to be looking into product development in this area and 2003/4 looks set to see a wider range of products and greater choice/competition in the area.”
One company actively considering entering the equity release market is Bristol & West, which is owned by Bank of Ireland. Debbie Staveley of Bristol & West says equity release is just one of a number of current initiatives being investigated and developed by its market development team.
She adds: “The depth of analysis required and the corresponding extended lead-time to launch should never be underestimated when your position is that of a responsible lender. Equity release is an excellent example of this. You could be forgiven for thinking that it is simply a variation on a theme, just another mortgage. But the long term and indefinite nature of this type of mortgage, means that it is fundamentally different from anything that we have developed before at Bank of Ireland/Bristol & West.
“As a result, we are working closely with a number of external consultants to ensure that all risks inherent in this mortgage are identified and quantified prior to launch, avoiding any potential future hiccups. Only when we are completely satisfied that we have all angles covered, will we commit to launch into this market.”
The remit of the adviser on these products is wider than that on many other products, and equity release clients should not be taken on lightly. Since there is a direct impact on the amount of potential inheritance available to the heirs of those undertaking this plan, it is vital that they are included in the advice process.
Usually, the family will be more interested in the comfort of their parents than the amount of money they will get when they die, but if the adviser has not involved the family from the outset, they could face allegations of mis-selling after the parents have died.
Cooley comments: “Although lifetime mortgages bear some relation to other forms of mortgages, the advice required is extremely specialised and just because an adviser understands mortgages or another aspect of financial services, he or she may not necessarily be best equipped to advise on equity release.
“Specialist skills required may include, for example, experience of dealing with the elderly. The adviser will need to fully assess the customer’s needs and motivations, the type of product most suitable, involvement of other interested parties such as family and heirs, legal advice, inheritance tax planning, the impact of the customer’s health and state of mind, and ensure that the customer understands the relative ‘permanency’ of the deals.”
The number of companies in the market is currently relatively small, but is set to expand. Norwich Union, the biggest provider, has around 40% of the market, and the rest is shared between the likes of Newcastle Building Society, Northern Rock, Scottish Widows and Legal & General, among others.
Despite few companies offering these products, the terms available from each vary dramatically (see Box inset on page 36). For example, the Northern Rock product is available at a 7.19% fixed rate or 7.99% capped rate for anyone over the age of 60. While Newcastle Building Society has a fixed rate of 7.5%, and a minimum loan of £5,000.
Since the amount of the loan is based on the value of the house, and because each company will pay a certain percentage of the equity in the house depending on the homeowner’s age, Newcastle BS might be a better company for those closer to the entry point in terms of age, but with a lower house value. It is this sort of point that the intermediary should consider when advising clients.
Robert Hollinshead, chief executive of Newcastle Building Society, says: “Releasing some of the value tied up in your home is an option well worth considering. It seems such a pity for elderly people to live on a shoestring at this stage of their lives, particularly when they have money locked up in their properties.
“In the 1980s there were a number of scare stories as some equity release, or home income, plans were at the centre of a mis-selling scandal [largely as a result of the negative equity environment that existed at that time]. I do, however, believe things are very different today. Firstly, most products, including Newcastle Building Society’s Lifetime Equity Release Plan, have a ‘no negative equity’ pledge.
“In our current scheme, interest is fixed at an attractive 7.5% throughout the entire period of the loan. This is rolled up rather than charged on a monthly or annual basis, so that the loan is repaid from the proceeds of the eventual sale of the house. The no negative equity pledge means that if these proceeds are insufficient, Newcastle will write off any shortfall, which should provide complete peace of mind.”
Pros and cons
All of the products that meet the Safe Home Income Plan (Ship) standards have this no negative equity pledge, including all of those in the Box inset on page 36, but the plans have a variety of pros and cons so it is vital that advisers understand them well.
Charcol, for example, is not keen on the Norwich Union plan because it is not possible to determine what the early redemption charge would be if the policyholder had to exit the deal early for some reason.
Cooley said: “Norwich Union’s products are not recommended because they have long term, up to 30 years, uncapped market-tomarket early repayment charges, which will be banned by the Financial Services Authority (FSA) when it starts regulating mortgages in October 2004. As a result, it is impossible to calculate what the early redemption charge (ERC) will be. The ERC could be very onerous, it could be nil or it could be anything in between.
“Also, they will not confirm the fixed rate that will apply to any loan at the time of application and the rate charged will be the prevailing rate at the time of drawdown. Therefore costs will have to be incurred on valuation and legal fees without knowing what lifetime fixed rate will be charged. Furthermore, if they [Norwich Union] increase the rate between application and completion they will not refund any valuation or administration and legal fees incurred.”
Cooley added that although Norwich Union’s Index Linked Cash Release Plan is available from age 55, which is a possible plus point compared to all other plans, “its interest rate at 4.89% plus the Retail Price Index for each year with a 10.14% cap on the total rate is higher than Northern Rock’s capped tracker”.
“Also this product has the same uncapped market-to-market ERCs as the provider’s fixed rate,” she says.
Ian Beggs of Norwich Union says that the rate of interest charged on the loan is fixed at 7.55%, and is available on the provider’s website. But he says that it had had a number of conversations with Charcol over its ERC.
He says: “The ERC is linked to gilt prices and it may not be quantifiable, but hardly anyone has had to pay that because it should be a proposition that people intend to live with for the rest of their lives. Customers have always got the right to move home if they need to move. The average redemption premium is a few thousand.”
However, the one thing that NU will consider that others will not, is lending on some properties that would not be considered suitable by some other providers.
Cooley notes: “For example, although Northern Rock and Norwich Union will both lend on sheltered accommodation, Northern Rock’s policy is more restrictive in this situation with regards to the property they will lend on. Therefore there will be some situations where if the client wants to proceed with a lifetime mortgage they may have to accept Norwich Union’s terms.”
Even though there are obvious advantages for those who are cash strapped, equity release will not be a good idea for everyone. Says Kay Lowe of independent financial adviser Equal Partners: “These plans need to be looked at very carefully and they certainly need to come under the Ship banner. They have different parameters and criteria. Maybe all of us will be in that position later in life. I do think these plans are a good idea, but advisers need to research the market thoroughly.”
Reducing IHT?
One beneficial side-effect of equity release is the possibility of reducing an individual’s inheritance tax (IHT) liability on death. This is payable at 40% on any amounts exceeding £250,000 and it does include the value of the person’s house.
Hollinshead of Newcastle BS says: “Rising property prices mean that more and more people will find themselves caught out by this tax – and at 40% it is a substantial hit on the wealth many people wish to hand down to their offspring.
“Homeowners can use an equity release scheme to reduce the value of their estate and, depending on their individual circumstances, reduce the IHT liability below or nearer to the threshold.”
Most couples own their house as joint tenants, which means that on death the full ownership of the house reverts to the surviving partner. If they revert to tenants in common, their share of the house, say it is split 50/50, can be willed to whomever they wish. It can, of course, be willed to the surviving spouse, but the main reason for doing this is to avoid wasting the full £250,000 allowance on the first death.
Cooley says: “Each party could gift in the will their share of the property to beneficiaries. The survivor could continue living in the property and this would not fall foul of the gifts inter vivos rules, even though the survivor would not be paying any rent for that portion of the property they did not own. It should be noted, however, that the beneficiaries would normally be subject to capital gains tax on any increase in the value of their share of the property from the date of the first death.
“While gifting part of the property on the first death to someone other than the surviving spouse can be a very effective way to mitigate IHT, it becomes a problem when the couple, or the survivor, want to raise a lifetime mortgage on the property to enhance their quality of life in retirement.
“The terms of a lifetime mortgage require the owners to live in the property and in most cases to be aged at least 60. Normally where a part of the property is gifted on first death to one or more children this condition will not be met. Therefore any lifetime mortgage already on the property will have to be repaid, and the only way to do this may be to sell the property. This would be a nasty twist of fate when part of the reason for taking out the lifetime mortgage in the first place may well have been to secure occupation of the property, with a reasonable lifestyle, until the second death.
“Furthermore, if the survivor’s circumstances were such that after the first death they wanted to use the equity in the property, of which they now owned only a part, to raise a lifetime mortgage it would be impossible to do so unless total ownership of the property was transferred back to the surviving spouse. Doing this would clearly require revisiting their IHT planning.”
This is just one of the many things that advisers would need to check before they sign someone up to an equity release mortgage. Although most people’s needs will usually be covered by the equity release mortgage plan, there are some scenarios where the home reversion loan will be more appropriate.
For example, if the client is aiming to raise the maximum possible from the property price, particularly if they are aged between 70 and 90, and if there is no inheritance issue. Also, extra cash can be taken later on if the house price rises, and reversionary lenders will take into account health impairments to determine life expectancy, which could be an advantage if the client is ill. Individuals may also be able to get a loan on a property that the equity release mortgage lenders will not consider.
Although the FSA will regulate equity release mortgages from October 2004, home reversion loans will not be covered, despite petitions to the Treasury from the industry that they should be included.
Cooley says: “The Treasury’s original decision to exclude home reversion schemes from FSA regulation was a potential cause for concern – and could leave vulnerable customers out in the cold. Home reversion schemes are very complicated products so require expert advice and the prospect of an unregulated selling environment is worrying.
“However, a section of December’s Green Paper on pensions stated: ‘The Government will be looking at options to create a level playing field for the regulation of equity release and home reversion plans to protect consumers and make the market work better.’ The whole point about the pressure to regulate home reversion plans to create a level playing field is that they are one type of equity release, just as lifetime mortgages are. If the Green Paper had said ‘equity release, including home reversion plans’ it would have been more accurate.”
Alison Steed is a personal finance writer for The Daily Telegraph