When is equity release a sensible option?

Making ends meet can be incredibly difficult for some pensioners, especially with the rising cost of living. If they are homeowners, most of their wealth may be tied up in their property, making them ‘asset rich but cash poor’.

Downsizing may be the logical way to access this to fund a better standard of living in retirement but this assumes people have a bigger property than they need and the appetite to move, which may dwindle in later life.

Many people are emotionally attached to their homes because of the memories they have made and the lives they have built. If they needed cash for retirement, they would probably be receptive to a way of staying in their home while accessing its capital value to help fund their retirement.

This can be achieved through equity release, where older people can borrow money secured against their property. However, the market has not had a great reputation in the past and was seen as very poor value for consumers.

There have been many changes, particularly in recent years, yet equity release is still seen by some advisers as a last resort. But is the modern equity release market better than this? Could it be the answer for asset rich cash poor pensioners who should enjoying their retirement rather than struggling financially?

The ‘bad old days’

Commentators who worked in equity release 20 years ago recall a very different market to what we have today and it is easy to see how it acquired its poor reputation. “I remember the bad old days – there were even TV programmes warning people off equity release,” says Sue Read, a former adviser who is now risk, policy and compliance manager at the Equity Release Council.

“Since then we’ve struggled to be seen in a more positive light, while equity release has evolved. It’s a fantastic product for the right people but it isn’t for everyone.”

Back in the day, there were only a few lenders in the market and product choice was limited. People could either do a home reversion plan – where they would sell part or all of the property to the provider in return for an income – or a roll-up lifetime mortgages, where the interest they owed on a loan secured against their property was compounded and grew very quickly over time.

In today’s market there is greater choice. Paul Glynn, chief executive of later life lender Air, says there are more equity release products today with ‘a raft of different features’ designed with individual circumstances and transparency in mind.

“If you move house, they are portable and the early redemption charges are now fixed and transparent – they were gilt-based back then,” he says.

Home reversion plans that, back in the day, led to criticism that lenders just wanted to get their hands on people’s properties at a discount, have fallen out of favour.

“Nobody does home reversion plans any more, it’s all lifetime mortgages,” says Paul Langley, a wealth planner at Succession Wealth. “The way I see equity release for some people who are asset rich and cash poor is that if you bought a bond for £3,000 and it’s now worth £300,000, you need to take a profit.”

Equity release today

Langley acknowledges many people do not see their home simply as bricks and mortar – even if they are not particularly attached to it, they see it as something to pass on to their children once they are gone. But there are times when people have few options to find the cash they need to live on, and equity release may be a lifeline. “You shouldn’t put yourself in financial dire straits or go without food or heat,” he says.

Langley points out equity release has wider uses, such as inheritance tax (IHT) planning. “Imagine a client has a £1m pension and house worth £1.5m. They have an IHT problem and, traditionally, they would take money out of pension. But it brings that money back into the estate and doesn’t deal with the IHT problem,” he says.

“If they do equity release, they will be getting more in terms of the growth in pension than the interest rate they’re paying on equity release. It creates a debt on your house and the pension is a way of servicing that.”

For Langley, the biggest problem with equity release right now is not the products themselves, but high interest rates – especially ‘unforeseen roll-ups’ where people have to stop making payments towards their loan and allow the interest to be compounded. He says many people are deferring their decisions to do equity release as they wait for interest rates to fall.

“If you look at someone age 60 who is going to take the maximum amount, they will be looking at a high interest rate of around 9%,” he says. If this interest is rolled up and compounded, Langley says this will quickly eat into the capital the client has in their property.

“I’ve done equity release fixed at 2.8% for life and it’s now 9.15% – that’s a big difference,” he says.

Read agrees the interest rate environment is prompting people considering equity release – and mortgages in general – to take their time.

“What’s interesting is that the gap between mortgage rates and equity release rates have narrowed. They are not perfectly aligned but they are now more in line with each other,” she says.

Read understands why people are waiting, but she does not think equity release rates will fall back to the competitive rates of the past few years. “We’ve historically had higher interest rates and we’ve benefited from much lower rates in recent years and that has spoilt us,” she says. “We’re now readjusting to the norm.”

Spotlight on advice

One of the biggest changes in the equity release market is that advice has taken centre stage. Reflecting the wider shift away from a transactional approach to advice following the Retail Distribution Review, the equity release market has become more focused on ensuring people are directed towards the best solution for their circumstances, whether that be equity release, an alternative such as a retirement interest-only mortgage, a mainstream mortgage or another solution that emerges during the advice process.

“Equity release is part of a whole suite of options for customers,” says Read. “When I was an adviser, customers used to smile when I asked whether they had considered getting a lodger. But you need to go through everything; that is the job of the adviser.”

Commentators say the key thing for advisers is to have a discussion with clients about affordability.

“A discussion around affordability should help to triage customers into a product,” says Glynn. Knowing what payments a client can make in later life and for how long means the more innovative products in the equity release market, such as those with mandatary payment periods, may be a viable option.

“When customers can make payments and service some interest, it impacts product design,” says Glynn. “It enables people to change the shape of the product and pass on the benefit to customers.”

Going through all available options with advisers also leads to clients who better understand the option they have chosen. “If the customer goes into equity release they will understand how interest grows over time and the difference that even small payments can make,” says Glynn.

Safeguards

When the equity release trade body Safe Home Income Plans (SHIP) – now the Equity Release council – launched in 1991, the aim was to create an equity release market in which the consumer was treated fairly and protected through minimum standards.

Read says two of the original core protections set by SHIP still stand – the ability to move home and security of tenure. But another three have been added since then – the ability to make overpayments as a right, the requirement to take independent legal advice and the ‘no negative equity guarantee’.

“Equity release got a lot of bad press when interest could roll up so significantly that the amount owed exceeded the value of the property,” says Read. “If a customer and their partner died and there was a shortfall, the lender had the right to ask the beneficiaries for it.”

Now, lenders are not allowed to approach the beneficiaries to make up any shortfall and have to take the hit themselves, possibly taking out insurance to cover that situation.

Read points out that the Equity Release Council has recently updated its standards to keep up with changes in the market. For example, it recently conducted an interim review to reflect the emergence of mandatory payment equity release plans, with advisers now required to cover income and expenditure as part of the advice process.

“We’ll be doing a major review of our standards in 2024, launching in early 2025,” says Read. “As the market evolves, we evolve.”

However, some advisers remain cautious in relation to equity release. Prajesh Patel, director at ADL Estate Planning, says advisers need to weigh up the cost of the loan against the potential return that can be generated from the released equity.

“The interest rate on the loan is always higher than a typical mortgage interest rate. When comparing this to the interest rate offered on a savings account, where the released equity will sit, the homeowner is making a loss equal to the difference between the two interest rates,” he says.

Any loss over the medium will put the homeowner in a more difficult financial position in the future, which makes Patel wary of it. “Equity release remains a last resort and the higher interest rate environment only exacerbates this,” he says.