For clients struggling to raise cash to pay for long term care, equity release could be an option. Peter Fisher explains
Recently, there has been a lot of coverage from various mortgage experts extolling the vast amounts of easy business that awaits lenders and mortgage brokers. The Council of Mortgage Lenders (CML) estimates the market potential at up to £100 billion while 2003 generated just over £1 billion of new completions.
For those new to the equity release market, the following definitions will serve as a useful introduction. Equity release is a generic term that covers all methods of releasing funds from residential property for elderly homeowners, usually aged 60 or over. It is normally financed in one of two ways.
The first is through a lifetime mortgage, which is a loan on the residential property secured by a first charge. There are no interest payments to the lender and the debt rolls up until redemption after the property is sold. This event is usually triggered after death, moving into long term care (LTC) or possibly downsizing. The maximum loan to value will range from 25% at age 60 to 55% at age 90.
The second method of financing is through reversions. Here the homeowner sells all or part of their property to a reversion company at a discount. They do not pay rent for the part of the property sold and any growth on that part of the property belongs to the reversion company. The discounted value, which the homeowner receives, is linked to age and life expectancy. The older you are, the higher the percentage received, typically the maximum will be about 60% of the value sold.
Innovation
A number of factors make the equity release market such a topical subject and potentially massive market. These include financial reasons such as sustained house price inflation, low rates of pension escalation relative to the cost of living, low interest rates for both savers and borrowers, poor investment returns, more estates suffering inheritance tax (IHT), and greater lender competition and scheme innovation. There are also demographic reasons such as the increasingly ageing but growing population of retired property homeowners.
Regulation also plays a crucial role. As the Financial Services Authority (FSA) assumes responsibility from the Mortgage Code of Conduct Board, the inclusion of reversions and specific examinations for advisers will help further growth. An enforced regulatory process combined with a visible raising of advice standards across the entire spectrum of the equity release market, will help create an environment of confidence. However, this will only succeed if the FSA is proactive in setting the highest ethical standards and the exams are seen to be truly robust in testing the knowledge base required of advisers.
Consumer attitudes are also changing. The stigma of equity release being a 'last resort' solution for families in financial crisis is now being replaced by retirees wishing to have a full and active life, and if it also reduces IHT, so much the better. Why survive on pension credit only to suffer IHT when you die?
Typically, clients may request loans or reversions for all of the following purposes:
• Increasing income to maintain preferred lifestyle
• IHT mitigation
• Making gifts to family, such as assisting house purchase
• Paying for homecare
• Improving lifestyle, including extra holidays, motor homes and second homes
• Home improvements
• Paying for private medical procedures
• School and university fees
• Paying off serviced loans
• Finance weddings
About 30% of buyers could be classed as crisis purchasers with 55% falling into the lifestyle category, and the balance being motivated by IHT mitigation benefits. While most applicants would usually like a lump sum, an increasing number also opt to take either a regular income or a drawdown facility. This has the benefit of limiting the interest charged to only the amount actually received.
Currently, the vast majority of business is being written via fixed rate lifetime mortgage schemes. Homeowners like the certainty of knowing how much the debt will grow and that house values are likely to continue to rise. Not surprisingly they want to retain full ownership rights. By so doing it leaves scope to borrow more at a later date and hopefully still leave a net value to their beneficiaries.
To date, product innovation has been limited. Most lifetime mortgage schemes focus either on fixed or capped interest rates to raise a lump sum. Northern Rock has recently launched a variant to their basic plan, which limits the debt to a maximum of 50% of the property's value on eventual re-sale. This guarantees a minimum value of 50% will always pass through the will.
Another, is the National Counties Flexible Drawdown Plan where there is an agreed maximum advance fixed at 6.99% for life at the outset. However, the borrower decides when to take the money and is only charged interest on the monies actually taken. Future planned innovation may include a lifetime mortgage where increased loan to values are offered to impaired lives. This facility is already available through certain reversion schemes, including Hodge.
Unfortunately rapid growth cannot be assumed. Various factors currently limit growth and will continue to do so unless competitive pressures from lenders and brokers lead to significant pricing improvements for clients.
There is some ground to be made on interest rates for example. The most recent succession of bank base rate increases have not been passed on to new borrowers. Though this can be attributed partly to little upward movement in longer term gilt market prices. If the average client lifetime mortgage is expected to last for ten years then the rate for equity release should be similar.
Competitive
For example, Britannia's ten year fixed rate is 5.59% and while the no negative equity guarantee and the no repayment requirement needs to be priced in, is the difference of 1.4% or greater really justified? Why should lifetime mortgage applicants be treated worse than re-mortgage borrowers with bad credit histories?
A close examination of the small print can also reveal some surprising information. For example, on the GE Life Cash Release Plan, the effective interest could be significantly higher in the early years, leaving the estate to pay around 30% interest if your client is unfortunate enough to die in the first year. However, it can be far worse for the client who opts for a reversion plan and also dies prematurely. This outcome effectively provides the reversion company with an early windfall payment. Some schemes however, will offer a small amount of compensation.
Equity release is a costly exercise to complete. Arrangement and valuation fees, advice charges by advisers and legal expenses will usually exceed £1,200 and can be more than double this with certain providers and brokers. Most of the costs are a little high and it may well be something that providers start to look at, but since equity release is just a specialist version of a re-mortgage why aren't the set up costs similar?
If lenders want to make a genuine mark, an idea would be to bear part of the establishment costs. For lifetime mortgages, the only significant gesture has come from Standard Life where they refund the survey fee on completion. At least, most reversion companies apply much lower set up costs and often also make a contribution to the applicant's costs.
Another worrying trend is the lack of knowledge sometimes displayed by established players in the market. Quite rightly the FSA deem this area to be 'high-risk', as there are clients who have not had the loss of State and Local Authority benefits explained to them when it was necessary.
For the adviser, equity release is not about finding the cheapest deal. It involves gaining a clear insight into your clients preferred ambitions for the rest of their lives. It then requires integrating the answers to the threats that may lie ahead, while all the while having a clear understanding of the State benefits system, LTC legislation and how it could impact on any recommendations made. In most cases, the advice will be to refer to a specialist dealing in this field.
Peter Fisher is a partner at NHFA
COVER notes
• Equity release is a generic term which covers all methods of releasing funds from residential property for elderly home owners aged usually 60 or over.
• Equity release can be financed two ways; through lifetime mortgages or reversions.
• Various factors currently limit market growth and will continue to do so unless competitive pressures from lenders and brokers lead to significant pricing improvements to clients.
