Equity Release – The Devil is in the Detail
Large numbers of elderly clients continue to regret having taken out these restrictive and costly plans. Meanwhile, the heavily resourced PR Departments of the product providers continue to produce veneer thin analyses, published in the press as “expert guides”, in support of these plans.
Sadly, the many costs and disadvantages of equity release are not discussed in these newspaper articles, and the conclusions are dressed up as independent “tips” and “guidelines” for the elderly. Alas, the market has not changed, and great caution should still be observed in advising on and using an equity release product.
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Equity release, also known as a Lifetime Mortgage or an Equity Reversion Scheme, is the means by which many elderly clients have released equity from their homes in the form of a cash lump sum. Cash that they can then use for whatever purpose they wish. This looks attractive, as many elderly clients in homes with no mortgage are equity rich but income and cash poor. However, the Devil is in the financial detail and most clients (and some private client practitioners) are unfamiliar with this detail.
In return for releasing the cash, the resultant debt comes at a high price. This is because the charge on the property “rolls up”, compounding through time. A Lifetime Mortgage, for instance, will accrue compound interest on top of the unpaid interest and the debt or charge on the property will become increasingly large over the years.
The detail is even worse for a Reversion Scheme. Instead of a compounding charge on the property, the elderly freeholder simply sells a large proportion of their home in return for a much, much smaller lump sum. This is hardly ever a good deal for a client and if equity release is ever deemed appropriate (and this should be in the minority of cases) the Lifetime Mortgage variant should be preferred.
The Compounding Charge
The charge that arrives with a Lifetime Mortgage is not easy to understand, even for the financially literate.
For example, a 7% fixed rate equity release of £100,000 will double in size to a debt of £200,000 after approximately 10 years. This debt will then double again to £400,000 after a further 10 years. By contrast, the equity release at a more competitive rate of 6% will take 24 years to double twice to a debt of £400,000. Both are very costly, though the former even more so.
It is rare to find a client considering equity release that is fully aware of the pernicious nature of the compounding debt over the long-term, and who is aware of the restrictions that will then apply to their mobility and options in retirement. It is likewise rare to find a client who has exhausted all of the alternatives to equity release before proceeding.
The alternatives to an expensive equity release are rarely fully exhausted by clients and advisers. These include the following:
- Moving to a smaller home.
- Securing an interest only mortgage.
- Obtaining an interest free mortgage from a family member. Potentially one who will, in time, inherit from the property owner.
- Reviewing the elderly client’s income and expenditure in order to determine whether extra resources and/or savings can be found elsewhere.
Money for a Rainy Day
It is a sad reality that some clients will release equity, compounding as a debt at 7% per annum, only to have the released cash sitting in a bank account earning 0.5% net interest. This is hardly a good deal for the client, even if they have exhausted all of the alternatives detailed above – which is rarely the case.
An Independent Voice
If equity release was only sold to those to whom it was suitable, the market for these products would be a small fraction of its current size. It is a market that trades on the lure of a cash lump sum and financial illiteracy. Elderly clients deserve more protection, and should never be advised to release cash simply for a rainy day fund.
Please visit www.which.co.uk. The independent voice of the Consumers’ Association can be trusted not to have a vested interest in the promotion of this product type.
Which? believes that, “the way some of these high-risk products are advertised is irresponsible”. Further, a January 2006 study by Which? concluded, “that equity release schemes should be used only as a last resort”, and that amongst other things, “schemes can be expensive, inflexible, and leave people with little or no equity in their home”.
When Equity Release is Suitable
I have yet to be convinced of any argument that Reversion Schemes are suitable in any circumstances. Lifetime Mortgages, while costly and often ill-considered before exhausting the available alternatives, may still be suitable, to a relatively small number of elderly clients e.g. a client who will move home and redeem the equity release in the shorter rather than longer term, or to an elderly client who has a lower life expectancy.
A Lifetime Mortgage may be suitable where:
- The available alternatives have been eliminated.
- The lowest possible compound rate of equity release “roll-up” has been secured. An Independent Financial Adviser will be required to find this, though most equity releases are sold direct from a single provider.
- The release of equity is staggered, monthly or annually, to supplement income. Thus greatly reducing the long-term “roll-up” cost compared with releasing the equity as one large initial lump sum.
- The elderly client has an obvious and great need for the capital released. It is not simply for a rainy day.
- The client is less likely to need the “roll-up” to continue for many years.
- A client has no beneficiaries and for whom the significant cost of a Lifetime Mortgage, over the long-term, is less of a concern because of the value to which the released money will be put.
If these checks or characteristics apply to the elderly client in question, then it is more likely that a Lifetime Mortgage will be suitable. Sadly, it is rare that their importance is made known to the client.
Please urge caution to your clients considering equity release. At the very least urge them to avoid Reversion Schemes, consider the long-term costs of Lifetime Mortgages, and seek independent financial advice.
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