You think your retirement funds are set in stone, but the cracks are starting to show
As the housing market turns, Laura Howard asks if equity release will offer a good deal to those counting on their homes for an income
Sunday 04 November 2007
In the wake of mis-selling scandals and poor investment returns, pensions have become a dirty word for many, and hundreds of thousands of Britons are relying on their homes to help pay for their old age. But even against this backdrop, and booming house prices, the rise of equity release schemes has been staggering.
According to industry body Safe Home Income Plans (Ship), some £32.5m worth of equity was released in 1995 as retired people looked to unlock some of the value tied up in their property and turn it into an income. This had risen to £524m by 2000, and in 2006 the total figure stood at a heady £1.2bn.
However, with many experts now predicting house-price falls, what will happen to equity release? Will the schemes on which so many Britons are dependent still offer enough to fund a secure retirement?
There are two types of equity release, the first and most popular being the lifetime mortgage, where a homeowner borrows against part of their property. The loan is not repayable until they die, sell the house or go into a care home.
The percentage that can be borrowed depends primarily on the homeowner's age and health – the closer you are to death, the more you will get. For example, a 60-year-old would generally qualify for a loan of only 20 per cent of the property's value, while those aged between 90 and 95 could borrow the maximum 50 per cent.
Compound interest applies until the loan is redeemed, which – depending on house prices and years lived – could eat up the entire value of the home.
This point is especially relevant now as lifetime mortgage providers could soon start moving the goal- posts due to a slowdown in the property market.
"Up until now, interest rates have been realistic – typically between 6 and 6.5 per cent," says David Kuo, head of personal finance at advice website Fool.co.uk. "But that's while equity release firms have been expecting house prices to rise.
"Now prices are showing signs of stalling, there are few options but to raise their rates," he adds. "Home- owners should be going back to the drawing board and comparing what difference this will make over five, 10 or even 15 years."
The equity release industry, however, is adamant that interest rates on lifetime mortgage deals will not change. "Current pricing models are very sophisticated and already factor in house price fluctuations," says Dean Mirfin, managing director of independent financial adviser Key Retirement Solutions.
But he admits that if house prices were to plummet, the size of the loans would also fall: "The current maximum lending criteria might come down so that, for example, a healthy 60-year-old would no longer be able to borrow 20 per cent."
The second type of scheme is home reversion – where the equity release firm buys a proportion of your property. More money can be released through this type of plan as it is possible to sell up to 100 per cent of the house while continuing to live there until death.
However, as there is no loan on which the provider can charge interest, customers will be paid much less for the chunk of the home they are selling. Depending on their life expectancy, they will typically qualify for between 30 and 60 per cent of current market value.
It is in the home reversion market that the most serious concerns are raised should house prices fall. Mr Kuo says customers may net even less in return for their bricks and mortar. "A typical homeowner selling 100 per cent of a £150,000 property may end up with £60,000 [40 per cent] rather than £70,000 [47 per cent] – which clearly means less money at their disposal," he argues.
Ship also admits that, as home reversion providers factor in house-price movements upfront, new customers may get a worse deal.
Mr Kuo urges homeowners to explore alternative options, such as trading down to a smaller property or using savings, before considering equity release.
At best, falling house prices will prompt consumers to check the small print before entering agreements. "It means the Ship guarantees on lifetime mortgages that have always been in place are becoming more relevant again," says Jon King, chairman of Ship. "For example, the interest rate on mortgages is fixed for the entire loan and, where rates are variable, they come with a lifetime cap. All Ship members also carry a 'no negative equity' guarantee, so the amount owed on a lifetime mortgage will never exceed the value of the home – even if it goes down."
This is not the case with all providers. Consumers should beware of unusually low rates as this may mean the plan does not have a "no negative equity" guarantee.
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