The perils and pitfalls of releasing capital from your home

Beware - equity release schemes can be overpriced and bad value

After five years of record growth in the residential property market, equity release schemes - which allow you to extract money from the value of your home - have quickly grown in popularity. Last year, the sector broke through the £1bn mark, with the Council of Mortgage Lenders predicting that by the end of the decade, it will be worth more than £50bn. Prudential, which entered the market last year, estimates that Britain's 60- to 70-year-olds are sitting on about £570bn of unlocked equity in their homes.

After five years of record growth in the residential property market, equity release schemes - which allow you to extract money from the value of your home - have quickly grown in popularity. Last year, the sector broke through the £1bn mark, with the Council of Mortgage Lenders predicting that by the end of the decade, it will be worth more than £50bn. Prudential, which entered the market last year, estimates that Britain's 60- to 70-year-olds are sitting on about £570bn of unlocked equity in their homes.

The product, which is typically available to those over 60, provides a useful, and sometimes crucial, access to extra cash for the elderly, and is certain to grow in popularity as increasing numbers find they have not saved enough to provide the kind of retirement that they would like.

But while the concept of equity release is both practical and straightforward, the reality in the UK market is quite different. In a new survey by The Independent, looking at everything from interest rates to standards of advice in the sector, the equity release market emerged as uncompetitive, overpriced and plagued by bad practice and bad value.

Worse still, many of the hundreds of investors who have been persuaded to make the wrong decisions remain unaware that they have frittered away thousands of pounds which could have been passed on to their children, or used to help them live a more comfortable retirement.

Here, we reveal the findings of our research, and provide some pointers as to what potential customers need to watch out for. If you want or need to release capital from your home, you will have to tread more carefully than you might think to avoid being ripped off.

INTEREST RATES

The most common sort of equity release scheme is essentially a mortgage, where the interest rolls up and is repayable when you die or sell the property. But the rates charged on these deals are well above typical mortgage rates.

Variable rate deals are up to 1 percentage point higher than standard mortgage variable rates, while the worst fixed rates are up to 2 per cent higher than the best 10-year fixed rate mortgages.

The providers' excuses tend to focus on the extra risk which they believe they are taking on. For instance, on every roll-up mortgage there will be a threshold after which time the provider will be at a loss. This depends on how long the borrower lives and what happens to property prices. But essentially, if the interest due plus the value of the loan accumulates to a sum which is greater than the total value of the property, then the lender will lose money.

If this was a likely scenario, then it would be understandable that lenders would want to cover themselves, but the reality is different.

For a 70-year-old, the most you can borrow on a roll-up mortgage is 30 per cent of the value of your property. So assuming an interest rate of 6 per cent, and a property worth £100,000 today, the borrower would have to live beyond 91 before the provider would lose any money - and that would be assuming that property prices did not rise at all in the next 20 years, which is highly unlikely.

Peter Fisher from the Nursing Home Fees Agency, which recently set up a new equity release advice service in conjunction with Help the Aged, points out that even people with bad credit records get better mortgage rates than those offered in the equity release market.

PENALTIES

Most policies carry penalties for early redemption which will be payable if you sell your home or decide to pay off the loan during the first few years.

Thankfully, the majority do not charge exit penalties for those who die early on. However, watch out for GE Life's plan which charges a much higher rate in the first few years, leaving your estate to pay around 30 per cent interest if you die within the first year.

CHARGES

Equity release is a costly business. Arrangement and valuation fees, survey costs, advice charges and legal expenses will usually come to at least £1,000, and can be more than double this with certain providers and brokers.

The most expensive companies, such as Northern Rock, charge £600 for arrangement fees alone. Some providers will also make you pick up the bill for their legal costs as well as yours.

The NHFA points out that remortgaging costs a fraction of this, with the provider often picking up the bulk of, or even all, your costs - an indication of the level of competition in the mortgage market compared to the equity release sector.

Dominic Ventham, from the Prudential, concedes that charges may be a little higher than ideal. "Admittedly most of the costs are a little high, but we are where we are," he says. "It may well be something that providers start to look at."

ADVICE

If you're using a financial adviser to choose and set up your equity release plan, then its important to be doubly vigilant over costs. Commission-based independent financial advisers will typically take 1 per cent of the value of a lifetime mortgage, or up to 2 per cent on home reversion plans. The provider pays these commissions direct to the IFA.

However, most brokers will make an additional charge to customers for advice. The largest specialist equity release adviser, Key Retirement Solutions, for example, charges £495 to customers that it deals with over the phone, or 1.5 per cent for those that it deals with face to face. The new Help the Aged service does not levy any additional fees.

If you are taking out a home reversion plan - where you sell a proportion of your property to the provider, but are allowed to live in your home rent-free until you die - watch out for how the charges are levied. Typically, home reversion plans pay just 40 per cent of the value of the stake which you're willing to sell. However, Key charges 1.5 per cent of the total stake value, not 1.5 per cent of the amount which it will pay you.

Dean Mirfin, a director of Key, argues that his business would simply not be viable if it didn't charge the extra fees, adding that Key is not the most expensive in the market. "I don't think anyone could turn around and say that anything we do is inflated," he says. "We are not a company that makes millions of pounds of profit."

Ideally, customers should also be sure to see an adviser that knows the long-term care market, and can advise you on the implications of taking out equity release for any state benefits that you may be entitled to.

LOAN SIZE

Another potential pitfall to watch out for is being persuaded to take out more than you need, and then advised to invest the surplus.

Advisers may argue that with a lifetime mortgage, there is no guarantee that a provider will let you come back to take more money from your property if you should need it, so you should take as much as you might ever need straight away. Ultimately, however, there is every chance that providers will let you take out another loan, as long as the size of the first is not too big.

There is seldom any point in drawing down more than you need in the immediate future. By reinvesting part of your money in an investment bond, your adviser will take home another few per cent in commission, as well as lumbering you with additional charges.

Remember, that in the case of money drawn down through a lifetime mortgage, where interest rates are typically 7.25 per cent, you will not be able to earn as much interest in a savings account as you are paying in interest to the lender. With top savings rates currently at around 5 per cent, you are effectively paying 2.25 per cent simply to keep your money on deposit.

'Help the Aged found

June Hartle, 68, from Oxfordshire, is all too familiar with the pitfalls of the equity release market.

After deciding to try to release some money from her home last year - to help her grandson get through university, and to help her daughter bring up newly born twins - she went in search of financial advice. After seeing the fees and commission that her local IFA was charging, she turned to Help the Aged to ask whether there was another way.

The charity sent round an adviser, who didn't charge a fee, and set Mrs Hartle up with a plan for a fraction of the cost she had originally been quoted.

"There must be so many who are taken in by the ads on television and these IFAs. But Help the Aged were brilliant and found me a much better deal."

EQUITY RELEASE: WHAT TO WATCH FOR

* Help the Aged and the NFHA are campaigning for better value and better practice in the equity release market. Their top tips for people thinking about equity release are:

* Consider the alternatives, such as moving to a smaller home.

* Discuss your plans with your family.

* Find a specialist IFA qualified to advise on long-term care as well as equity release

* Ask your adviser about their fees

* If you are already in poor health, it may be possible to get better terms from your provider. Ask your adviser to check.

* When looking at interest rates always look at the APR, not the headline rate

* Make sure you have a solicitor who is familiar with equity release

* Contact Help the Aged on 0845 2300 820