Equity release mortgages

The majority of equity release schemes involve homeowners taking out a lifetime mortgage to provide a cash lump sum, or a series of lump sums by way of a drawdown facility or an income for life, as a means of boosting retirement income. In most instances the interest on the mortgage will be rolled-up and eventually paid off from the sale of the property when the homeowner either goes into long term care or dies.

Why has equity release become so popular?

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 good final salary pensions in retirement and instead have to manage on tiny pensions bought from the proceeds of private pension provision. Buying ‘inflation proofing’ via a money purchase pension is extremely expensive, so few retirees buy this when they purchase an annuity.

You may want to use equity release schemes to fund your aspirational desires: for example, home improvements; a world cruise; or to help your children or grandchildren start on the property ladder.

An increasing number of people are entering retirement with substantial debt obligations (for example an outstanding mortgage, credit card or personal loan debts) and debt repayment has become an increasing driver in the demand for equity release schemes.

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 Financial Services Authority (FSA) and new drawdown products, which allow people to draw down small lumps sums in stages, have made lifetime mortgages increasingly flexible. An advantage of drawdown is that you are not actually charged interest on each drawdown tranche until it is actually taken.

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

The low interest rates available on savings accounts with the banks and building societies have also significantly reduced the income that savers are getting.

SHIP code of practice

SHIP 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.

Its Code of Conduct provides firms with strict criteria that need to be met in order to become a member. The following guarantees have to be provided to customers:

To allow customers to remain in their property for life provided the property remains their main residence;

• To provide customers with fair, simple and complete presentations of their plans;
• The right to move their plan to another suitable property without any financial penalty;
• The right for the customer to choose an independent solicitor of their own choice to conduct their legal work;
• The SHIP certificate signed by the solicitor is there to ensure clients are aware of the terms and implications of the plan including the impact of equity release on their estate;
• All SHIP plans carry a no negative equity guarantee. This means customers will never owe more than the value of their home and no debt will ever be left to the estate.

Under the 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 Financial Services Authority regulated firms).

Releasing equity

Cash can be released from a property in various ways including:

• A lifetime mortgage
• A home reversion
• Trading down to a cheaper property
• Remortgaging
• Sale and rent back.

Lifetime mortgages

A lifetime mortgage involves taking out an interest only mortgage against the value of your property. Typically it will be at a fixed interest rate for the duration.

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). The lifetime mortgage can be taken out on a joint basis, which means that the property would be sold on the last death or entry into a residential nursing home.

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 mortgage 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 because the interest is rolled up, you remain responsible for the repair and maintenance of the property and all household-related bills.

Some equity release providers offer a drawdown facility, whereby you can choose to take an initial advance and draw on this, as and when required. A new fixed rate of interest may be 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. This is 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.

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, particularly in the case of impaired life), and generally there is no formal 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. 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. You should also consider whether it will affect your income tax liabilities.

Home reversions

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

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

As is the case with a lifetime mortgage, you continue to live rent free in the property for the rest of your life, or until you permanently move into a residential nursing home if earlier, 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.

By contrast – and as a generalisation, with a lifetime mortgage – it is impossible to know at the outset the value of the equity, if any, will remain for your heirs, when the property is eventually sold because no-one knows how long your equity release scheme will last or what the property will be sold for. However, some lifetime mortgages will permit you to protect a percentage of the property value for your estate and there are also some lifetime mortgage schemes that fix the level of debt at the outset.

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% 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*.

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 in poor health, you should 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.

Consult a qualified adviser

Equity release schemes are by their nature potentially very long term contracts and, as such, you really should get professional advice from a qualified adviser if you are contemplating equity release.

You should be aware that a special qualification is required to give advice and arrange this type of mortgage and therefore many mortgage brokers will not be able to help you. The adviser should help you explore your other options and may, for example, determine that another solution may be more beneficial for your circumstances.

The adviser should also be able to clarify the effect of any equity release funds on your state benefit entitlement as well as any likely effect on income tax. If the adviser deems that equity release may be suitable for you, and you agree, the adviser should also explain to you, and consider whether, a lifetime mortgage or a home reversion scheme would be more appropriate for your circumstances.

The adviser should explain and discuss how the schemes work, what scheme facilities are available and which of these facilities may be preferable for you. The adviser should also explain the implications of any chosen scheme should your circumstances change in the future.

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 planning.

It is also advisable that you consult your own solicitor, so that you have another source of independent advice.

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. These, 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.

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.

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.