Posted on: 12-09-2017 in Mortgage & Property
Equity release loans are becoming popular as part of the retirement strategy of many UK homeowners. Equity release loans (also known as “lifetime mortgages”) can fund a change in lifestyle or gift a family member in the short term, but borrowers need to be wary of the potential financial impact on their retirement plans.
There are hefty charges involved in equity release loans (relating to repayment as well as inheritance) that should prompt responsible retirement planners to pause, take stock – and pick up the phone to their financial adviser.
Equity release is a loan that is borrowed against the value of a home without having to make monthly repayments. Instead, interest rolls up over the life of the plan.
The loan can either be in the form of a one-off lump sum or secured in regular payments; there is a degree of flexibility.
The loan itself gets paid off usually on death with the sale of the property, with the loan itself affecting the value of the house detrimentally at that point, too.
Chiefly because the popularity of equity release among homeowners has increased swiftly: the Telegraph in July cited figures from the trade body, Equity Release Council, that more than £700 million worth of cash was accessed by homeowners between April and June this year. The market is maturing. Be sure to review the facts before you get swept away with the crowd.
First, we read this summer that banks have been ordered by the Financial Conduct Authority to hold more capital – rather than see cash walk out the door in the form of personal loans.
Then, we find warnings from the experts about the affordability of mortgage repayment in the event of a future interest rate rise – even though today’s Bank rate is rock bottom.
On this theme, we also read that the Bank of England wants banks to ‘stress-test’ their mortgage applicants: assessing not just if they can afford today’s repayments but assess them against a future scenario in which the base rate jumps higher than 5%.
That’s not very fair, you may say! So, it makes sense that older folks would want to help their next of kin with that initial lump sum deposit available with an equity release loan.
Savings rates have been low for some time, as per a Bank of England base rate of little more than zero. We’ve seen how credit card debt continues to rise in the UK population; partly due to a low appetite to save amongst consumers with such little returns on offer.
Since actuaries agree that people are living longer, retirement calculations can be complicated. Robust financial planning is only possible in this area with a professional adviser. But, where there are financial shortfalls, people seem to be increasingly turning to their chief asset, their house.
Equity release allows borrowers to exchange the regular monthly mortgage payment with deferred repayment. Clearly this saves a lot of cash over a typical year.
While it might be doom and gloom for first-time buyers within the younger generation, the cost of equity release loans has in fact fallen over the last year.
Research by Key Retirement, cited and summarized in The Telegraph, shows that borrowing at 3.94% today allows more than £70,000 in savings on interest payments over the course of the loan compared to the typical rate of 5.92% five years ago.
Today’s rate quoted here really is at the lower end of the scale, however. Equity Release Council, the industry trade body, reported that the current average loan rate is 5.35%, with 4.5% common among some end-lenders.
Since April, individuals in the UK have been able to claim an extra £100,000 worth of estate that won’t be subject to inheritance tax – on top of the existing £325,000 – if it is passed on to a survivor. The equity release reduces the taxable value of an estate, so when the borrower dies, the mortgage is paid off from the estate’s value, with IHT then only due if the resulting value is still above £325,000. Potentially, therefore, IHT could be reduced to zero using equity release.
Where equity release loans hit the consumer is in the poor deal that you will be offered – consumers regularly end up mortgaging their property for a fraction of its market value, simply to take advantage of the release of equity right now.
You must read carefully not just the headline rate but all terms and conditions.
In particular, make sure to scrutinise the repayment charges and any early repayment charges.
If you’re considering equity release for purposes other than for a cash gift, perhaps consider other means of raising cash. Are there simpler ways of buying those home improvements, or holiday? Our credit card article from July has some good tips on how to take advantage of credit card deals and cut down on interest repayments.
On the subject of credit, bear in mind too that taking out an equity release loan will have a big negative impact on your credit profile. This may make it hard to get other types of loans later on. So if you have a number of years left in you (apologies!) and you’re looking to help a child or grandchild use cash from equity release, you may struggle to take advantage of a buy-to-let mortgage opportunity, for example – where previously, as a homeowner, you’d be a bank’s preferred client.
As we always say, get to the bottom of equity release by sending a quick email to your financial adviser. Equity release is a one-way journey: you must be absolutely sure that you are aware of all future financial consequences, and here real experience helps to keep you safe. Equity release could unlock some real potential for you and your family – but only so long as all the bases are covered.