Although equity-release products are becoming increasingly popular, don’t forget the risks.
More older Britons than ever before are funding their retirement by borrowing against the equity built up in their homes, with sales of equity-release plans more than doubling over the past five years. Roughly 37,000 homeowners over the age of 55 secured more than £3bn of funds during 2017, according to the Equity Release Council (ERC), the industry body.
The plans are also rising in popularity compared with withdrawals from pension plans, according to the ERC’s data. For every £1 of savings withdrawn from private pension funds during the final three months of last year, 56p of home equity was released – that is compared with only 29p just 18 months previously. In part the increased use of equity-release plans reflects the way strong house-price growth in recent years has resulted in many Britons having very significant wealth tied up in their homes. The value of the average house in the UK increased by 50% between 2005 and the end of last year, according to government data.
However, equity-release plans may also have been boosted by the pensions freedom reforms of 2015, which allow savers to draw an income directly from their pension funds while continuing to invest what remains. Some savers appear to be supplementing their income drawdown with cash sourced from equity-release plans, reducing the amount they need to take out of their pension – and leaving more capital in the fund to continue growing.
Read the small print
With careful financial planning, this approach could work well for savers, particularly if they are able to earn better returns on their pension investments than the interest costs they incur on equity-release plans. However, there are real pros and cons to these products – and the small print varies enormously from one provider to another. Most obviously, equity-release plans are expensive, and could leave you with little or no equity in your house to bequeath to your heirs (although needless to say, this shouldn’t take priority over your own quality of life).
The typical lifetime mortgage (see below) costs a little over 5% last year – well ahead of the cheapest conventional mortgage rates. This would turn a £75,000 loan into a debt of more than £275,000 over 25 years. In the worst-case scenario, you could even end up owing more than the value of your house, though reputable providers have a “no negative equity” guarantee.
Similarly, were house prices to rise by 50% again over the next 12 years, as they did between 2005 and 2017, the amount repayable through a reversion scheme could almost double. Since providers don’t pay full market value for their share of your house, they benefit disproportionately from house-price growth. The schemes can also be inflexible. They may limit your ability to move house, for example, which could cause real problems should you need long-term care. There are often high penalty fees to pay on any early repayments you make. And releasing capital in this way may affect your entitlement to stage benefits.
Schemes are improving
On a more positive note, equity-release providers have sought to improve their products in recent years. For example, many now offer a drawdown product, enabling borrowers to take cash as and when they need it, rather than in one lump sum. This can reduce the final bill on the debt. Providers also have to abide by strict rules on the information they must disclose to would-be borrowers. It’s also worth noting that the ERC also operates a code of best practice, which all reputable providers now subscribe to. If you’re considering equity release, just make sure to take independent financial advice to ensure that it’s appropriate for your financial circumstances.
Tax tip of the week
Most open-ended investment companies and unit trusts are available in both income and accumulation share classes. Although each fund receives income throughout the year on its underlying holdings, if you invest in the accumulation shares, your part of this income will be automatically reinvested, and this will be reflected in the value of your holding, says Shares magazine. Importantly, any income that is automatically reinvested into a fund is not liable for capital-gains tax (CGT).
If you’re a holder of accumulation units, you should keep a record of all your “notional distributions” (the income that has been rolled up into your accumulation units) so that when you come to sell your holding, you can subtract this amount from your profits for CGT purposes. This information is found on your consolidated tax certificate.
How equity-release plans work
Most equity-release products fall into one of two categories. With a lifetime mortgage, you borrow a proportion of your property’s value, with the money repayable when you die or sell your house. You don’t have to make any repayments in your lifetime, but this means you – or your estate – end up paying much more interest than you would on a conventional mortgage, since the charges are added to your debt, which steadily escalates.
Home-reversion schemes, meanwhile, involve selling a share of your property; when you die or sell your house, the provider gets its share back as a percentage of the sale price. You won’t get the market value of your house when you take out the plan – the provider can’t tell when it will get its money back, so to compensate for the risk, it pays less than the market value for its share.
Most providers will only consider applications from the over-65s, although in a few cases 60 or 55 is the lower limit. However, the younger you are when you take out the plan, the more it will cost, assuming an average life expectancy. Lifetime mortgages are regarded as more suitable for older borrowers, because there is less time for interest to compound. Cash released from an equity-release plan can be used as you see fit. The money could be used for a one-off purchase, but borrowers typically use it to supplement their retirement income – often by investing in an annuity paying a guaranteed level of income.