Defaqto

Why has equity release become more popular in recent years?

People are living much longer than they used to, meaning that increasing numbers of retirees are falling into poverty as they grow older because their pensions become eroded by inflation.

Fewer people nowadays are in receipt of a good final salary pensions in retirement and are instead having to manage on tiny pensions bought from the proceeds of money purchase pensions. Buying inflation proofing via a money purchase pension is extremely expensive, so few retirees buy this when they purchase an annuity.

The trade body, Safe Home Income Plans (SHIP) has done much to make equity release schemes more secure through its code of conduct and safeguards such as its ‘no negative guarantee’ that all SHIP members have to sign up to.

Lifetime mortgages and home reversions are both now regulated by the FSA and new drawdown products, which allow people to draw down small lumps sums in stages, have made lifetime mortgages much more flexible and attractive.

Rapidly rising house prices in the period between 1997-2007 have also made many retirees 'property rich' giving them much more equity in their homes to draw down than would have been possible 10 years ago.

SHIP code of practice

SHIP stands for Safe Home Income Plans and is a trade body which was launched in 1991 to promote safe equity release schemes to the general public. Today it has over 20 members including banks, building societies, IFAs and insurers.

All participating companies are entitled to use the SHIP logo on their marketing literature on condition that they adhere to the SHIP Code of Practice.

This binds member companies to:

• provide a fair, easy-to-understand presentation of their plans so that any scheme using the SHIP logo is properly explained and safe;
• ensure that the client’s solicitor, who oversees the transaction on their behalf, signs a certificate confirming that the essential features and implications of the scheme have been properly explained;
• no SHIP endorsed equity release plan will proceed without this certificate;
• provide a ‘no negative equity’ guarantee whereby the provider guarantees that the client’s home will never be repossessed, (even if the outstanding mortgage on death exceeds the sale value of the property).

Under the SHIP code of practice, complaints about an equity release product must be dealt with according to a strict timescale. This includes a five day turn around for acknowledgement of the complaint, prompt investigation and regular updates on progress.

If you are unhappy with the outcome of this investigation, you can refer your complaint to the Financial Ombudsman Service (for FSA regulated firms). See how to complain, under the 'Loans' section.

Releasing equity

Cash can be released from a property in three principal ways, via:

• a lifetime mortgage,
• a home reversion,
• or by trading down to a cheaper property.

There are other forms of equity release, such as home income plans and shared appreciation mortgages, but these have proved to be risky to client, so these products will not be covered here.

Lifetime mortgages

A lifetime mortgage involves taking out a fixed rate, interest only, mortgage against the value of your property.

You pay no interest during your lifetime because the interest is rolled up and the entire loan (capital, plus interest) is repaid from the sale of the property on your death, (or on moving into a residential nursing home, if earlier).

If there is any equity remaining after the mortgage has been redeemed,  this will pass to your estate. This could happen if the value of your home rises rapidly while you have a lifetime mortgage, but there is no guarantee that this will happen.

The size of the mortgage (or cash facility) you are offered by the mortage lender will depend on your age, state of health and the value of the property at the time you apply.

Clearly, the younger and healthier you are when you take out a lifetime mortgage, the smaller the sum you can borrow because of your longer life expectancy.

How lifetime mortgages work

A lifetime mortgage can provide:

• one-off cash lump sum;
• further cash lump sum drawdowns (whereby you withdraw small lump sums in stages);
• a guaranteed income for life via an annuity;
• a combination of lump sum and income                                 

Although you don’t have to make any monthly mortgage repayments, you remain responsible for the repair and maintenance of the property and all household-related bills, such as council tax and service charges.

Some equity release providers offer a drawdown facility, whereby you can choose to take an initial advance (from the total amount you are allowed to borrow - called the ‘cash facility‘) and draw on this, as and when required. A new fixed rate of interest is agreed for each fresh advance.

This enables you to hold down the cost of borrowing because you only pay interest on the funds you have actually drawn down, rather than having to pay compound interest on a large initial lump sum, which may be bigger than you really need.

If you need to move into residential care, most providers will insist that the house is sold and the mortgage redeemed (unless there is a spouse or another individual registered on the mortgage still living at the property, in which case the mortgage is redeemed on second death).

However, a few providers will allow an individual or a couple to rent  their property while in a nursing home.

If you wish to move house, this is possible, providing the new home meets your lender’s mortgage criteria and there is sufficient equity remaining in the existing property. However, you are responsible for all the costs of moving.

The youngest member of your household must normally be over 60 years old to be eligible for equity release (although a few providers will accept people over age 55), and there is no upper age limit.

Cash released is tax free on receipt, but once you invest this cash, it may become liable to income or capital gains tax, depending on where you invest it. If the mortgage is repaid early (for instance if you  move into care), there may be an early repayment charge.

It is essential that you consider the effect of equity release on any state benefits you are receiving or might be eligible to receive in the future, such as pension credit, council tax rebate and some care allowances (see below).

Home reversions

The principal alternative to equity release (other than trading down to a cheaper property) is do a home reversion.

These schemes have been regulated by the FSA since April 2007 and involve you selling a percentage share of the value of your home to a reversion company in return for a fixed lump sum, or an income for life.

You continue to live rent free in the property for the rest of your life, but remain responsible for its repair and maintenance and all household-related bills.

On death, the reversion company sells the property and receives the value of the percentage you sold it, while your estate will receive the value of the proportion of the property you retained.

For instance, if you sell 50 per cent of a £250,000 property, you know that your estate will receive 50 per cent of the prevailing value of your property when you die. So if the house is worth £500,000 when you die, your estate will receive £250,000.

This makes home reversions attractive to people who want to know that they will be a ble to bequeath a certain percentage of the value of their home to their heirs when they die.

By contrast, with a lifetime mortgage, it is impossible to know at the outset how much equity, if any, will remain for your heirs, when the property is eventually sold.

The amount that a reversion company will offer you depends on your age, state of health and gender. This is because the reversion company will be making a guess as to your likely life expectancy.

For example, a 67 year old man with a 65 year old wife, selling 50 per cent of a £250,000 property might receive around £43,750, although this could vary depending on their state of health and the condition of the property (Source: Home & Capital).

This example shows the deep discount that you are required to sell at if you are in normal health for someone of your age. However, if you are older and in poor health, you will clearly be offered more because of your reduced life expectancy.

WARNING!

The only way to extract the full market value from your property is to sell up and trade down.

Both lifetime mortgages and home reversions effectively require you to sell your home at a deep discount in return for cash.  With a lifetime mortgage, there may be no equity left in the property at all by the time you die.

Anticipated trends

Over the next 25 years, the number of people of pensionable age is expected grow by 50 per cent to 15 million by 2020. These people will need additional capital or income in retirement, either because they face hardship in retirement or because they want to improve their quality of life.

The Institute of Actuaries estimates that there is £1,100 bn of largely untapped housing wealth owned by the over 65s and that 4.3 m retired people could benefit by releasing equity from their homes.

In 2006, the equity release market was worth around £1.5bn and this is expected to reach £3bn by 2012, according to SHIP.

Poor pensions, incresaing life expectancy and higher lifestyle aspirations mean that many of today’s pensioners want extra cash, not just to pay the household bills, but to maintain a decent standard of living and to be able to splash out on a few of life’s luxuries from time to time.

Key questions to ask your adviser

• What are the costs?
• What interest rate will I pay?
• Is this a fixed rate for life?
• How do you calculate how much I can release?
• Will this be via a lump sum, a monthly income , or a combination of both?
• What happens if I want to release more cash at a later date?
• What happens if the loan, plus interest, exceed the value of my property by the time I die?
• What guarantees are there that my home won’t be re-possessed?
• Is the provider a member of SHIP?
• What happens if something goes wrong? Who can I complain to?
• Can I move house at a later date?
• What happens when my spouse dies?
• What happens if someone else comes to live with us? (ie sibling or other relative)
• What happens if one of us goes into care and the other wants to stay in the property?
• Is the provider a strong, trustworthy company with a good reputation which will still be in existence in 30 years’ time?
• Will I pay a penalty if I repay the mortgage early?
• How do you calculate this penalty. Does it apply indefinitely?
• Can I use my own solicitor to do the conveyancing?

It is highly recommended that you discuss equity release plan with your family. Although no one is obliged to tell their children what they are doing with their own money, given the inheritance implications for your heirs, it is best that family members are aware of what you are doing, in order to avoid subsequent mis-selling claims and disputes on your death among your beneficiaries.

Many children nowadays are significantly better off than their parents and are happy to see their parents enjoy their retirement and join the ‘skiers’ (pensioners who ‘Spend the Kids’ Inheritance‘).

It is also advisable that you consult your own solicitor, so that you have another source of independent advice, in addition to your financial adviser.

Means tested benefits

Pension credit has been available to poorer pensioners since October 2003 and over half of pensioners are now in receipt of it.. This, together with council tax benefit, are the two principal means-tested benefits which retirees may be eligible for.

There are prescribed FSA regulations which IFAs must comply with when advising clients who are in receipt of state benefits or who might become eligible for state benefits in the future. These include the need to consider the following:

• your eligibility for benefits which are currently not being claimed, but could be in the future, and which might reduce or eliminate the need for an equity release plan;
• an assessment of the interaction between the proceeds from an equity release plan and any means-tested benefits already being received.
• If you are receiving council tax benefit or pension credit, then any income or capital received from an equity release plan could affect your entitlement.
• Loss of state benefits could also mean you having to pay more for dental treatment and glasses and the loss of your right to claim from the social fund.
• You might also have to pay for any care services being received or face an increased charge for such services.

WARNING!

Your financial adviser is required to confirm in writing that the overall advantages of the plan outweigh any loss of state benefits.

Key points to remember on state benefits

If a cash lump sum from a lifetime mortgage increases your total savings to more than £6,000, this could reduce the benefits you are entitled to or stop your eligibility for benefits altogether

Council tax benefit will be reduced by 20 per cent of the equity release income you receive. For instance, if your equity release income is £50 a week, your council tax benefit will be reduced by £10 per week.

How equity release interacts with state benefits in practice

Although, cash lump sums and income generated by an equity release plan are tax free at the point of receipt, they may become taxable once invested.

But how benefit offices treat invested equity release money is complex as there is little uniformity of practice across different benefit offices.

For instance, the treatment of cash lump sums taken for immediate expenditure is a grey area. If, say, £10,000 is deposited in your bank or building society account for immediate expenditure, will it count towards your savings when they are assessed for means-tested benefits?

Some benefits offices say that a £10,000 lump sum will not affect benefit entitlement, providing the money is spent within one month (for instance on home improvements).

Other benefits offices have ruled that the moment the money lands in your bank account, it forms part of your savings and will count towards the £6,000 savings limit.

Also supposing (in scenario one above), cash for immediate expenditure is unintentionally left on deposit for six months because your builders don't start work on time.

The benefits office which was willing to turn a blind eye to a short term deposit may well include it after six months, in which case your entitlement to state benefits might be jeopardised.

Because there are no firm guidelines, it is strongly recommended that you contact your local benefits office to ascertain exactly how the money from your equity release plan will be assessed with regard to your entitlement to means tested state benefits.

For instance, ask your local office how it would deal with the scenarios described above.

For further information, Age Concern provides fact sheets and booklets on entitlement to benefits.

http://www.ageconcern.org.uk/AgeConcern/is7.asp?TextSize=medium