Equity release: worth the risk?

The devastating impact of the coronavirus crisis will mean that even older, wealthier individuals may now be seeking to fill a hole in their finances. Dividend income has collapsed, as have bond yields and the rates on many savings products. Some individuals have suffered capital losses amid the market volatility of 2020, while others may wish to help relatives in dire financial straits as mass redundancies kick in.

Homeowners aged 55 or older who have paid off their mortgages may now be considering equity release as a new source of finance. The entrance of household names such as Legal & General, Aviva and Nationwide Building Society into the space has drawn greater attention to this industry, while the doubling of membership of the Equity Release Council in the two years to January 2020, and the number of TV adverts promoting their products tells us something about the lucrative nature of this market.

Forced improvements on these products in recent years may mean they are now better suited to your needs than they once might have been. But this is still an area that requires extensive research, as well as an awareness of the many drawbacks involved.

Taking out an equity release product is a major decision with significant and lasting effects on your finances and wider circumstances. Importantly, they can erode your property equity and eat away at any inheritance you may wish to pass on in future. Lifetime mortgages which “roll up” the interest can leave your estate with huge bills because of the effect of compounding. Equity release agreements can also mean you sacrifice some of the gains if house prices rise in future. With home reversion plans, you should also be aware that a lender might already be buying some of your equity at a discount to the market rate.

Equity release can also generally mean a sacrifice of flexibility. If you wish to use such a product and then want to pay off the debt and exit because of a change in your circumstances, you might be hit by an early repayment charge. The conditions of an equity release product could also limit your options when it comes to downsizing or changing your circumstances in other ways.

“With portability [moving the loan to a new property], the lender can make a judgement on whether a future house would be suitable as protection against the borrowing,” notes Stephen Lowe, communications director at Just Group, which focuses on equity release among other areas. “There are certain residential retirement villages that lenders might not see as an appropriate portability option – there may be elements in the leasehold arrangements that make it not safe for the lender.”

Customers should also consider their own longevity, and the consequences of using an equity release product for an extended period. If they were to live for 30 or 40 more years, they could reach a point where they are unable to make repayments, meaning the interest on the loan accumulates and wipes out an amount they wished to pass on to their children.

How equity release is changing

Jim Boyd, chief executive at industry body the Equity Release Council, points out that many products now have greater flexibility built in. More than half of equity release products allow customers to either downsize to a different property and repay their equity release plan in full, either voluntarily or if the new property doesn’t meet the lender’s criteria.

As noted, some lifetime mortgages also allow customers to make partial repayments of the loan without any penalty – though breaching a certain threshold can incur an early repayment charge. Such repayments can be important for preventing interest from compounding and massively increasing the ultimate debt your estate is left with.

Other innovations should protect consumers from some major downsides of equity release. Some products come with inheritance guarantees that ring fence some of the property’s value, often up to the threshold for inheritance tax (IHT).

Other guarantees are important, including security of tenure. “Someone can live in that property for life unless they go into care,” Mr Boyd notes. “We also have the no negative equity guarantee, where the loan cannot exceed the value of the equity. That’s important if you think property prices may fall.”

Other areas exist where some in the industry hope to see further innovation. Will Hale, chief executive at equity release provider Key, would like to see greater flexibility when it comes to early repayment charges.

“We’ve made progress from charges being gilt-based to fixed, but I’d like to see them not applying for a short period [from when a customer enters an equity release agreement]. People may not be clear what their plans are. People can come into significant inheritances. If they get a lump sum it might be cost-effective to pay off their equity release mortgage.”

Similarly, he would like to see increased leeway around the different kind of properties customers are allowed to move to. “Customers may suffer from a health condition or situation where a house with three storeys isn’t appropriate and they have to move to something more suitable,” he explains. “You don’t want the equity release loan to prevent them from doing that.”

Shop around and remember the alternatives

Equity release will only be suitable for a fraction of those with an interest in such products. Mr Lowe says: “For every 100 customers we advise, we would advise 50 not to use equity release because they can find other sources of income. Could they claim state benefits they are not claiming?”

Nick Baker, chief marketing and innovations officer for Free2, a firm with a focus on financing options for the over-55s, notes that several alternatives do exist. These include dipping into any existing savings or investments, taking money from a flexible pension or seeking an unsecured loan. Those looking to raise capital could also potentially do so by selling their current home and downsizing to something cheaper.

Consumers will have to go through a financial adviser if they wish to use equity release, so the pros and cons as well as any alternative options should be assessed. “People can’t come and buy one of these off the shelf,” notes Mr Lowe. “They can only have a conversation if they basically speak to a professional who is trained and qualified by the FCA. You also need an independent solicitor.”

Your choice of adviser will be an important decision. While those with a more holistic approach may be able to outline different potential sources of income, Mr Lowe argues that consumers should generally go with advisers who are “regularly in the market”. Also note that advisers will have different charging structures: some might make money through fees charged to product providers, while others may charge the consumer directly. Costs can vary notably.

Those considering equity release may also want to involve their family in conversations about the options being considered, given that going down this route can erode any inheritance. They should, at least, inform their children if they do go ahead with an equity release product. “There’s the big issue of communication between those taking equity release and their children,” Mr Baker notes.

As noted in the article, some of the issues and limitations of equity release may be resolved by innovations in the market. But anyone considering this route should carefully consider the implications, and any alternative options, before committing.