Equity release can be answer to ‘asset rich, income poor’ problem

Many retired people find they are ‘asset rich’ but ‘income poor’. A boost to money in retirement sounds appealing. The answer probably lies in taking some of the value out of their greatest asset – the family home – but comes at a cost.

Thousands who saved in pension plans for decades find their retirement income is far lower than expected. Much of the fault lies in the lacklustre performance by pension insurers.

Between December 2009-March 2013, the cost of purchasing a retirement income has jumped by 29 per cent. In 2009 a £5,000 income would have cost a man £118,000 and a woman £133,500. Today, according to adviser Hargreaves Lansdown, based on unisex annuity rates, the cost is £152,800.

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Equity release is the term for taking some of the value out of your home whilst having the security to continue living in it. Key Retirement Solutions, a broker in this field, says the main reasons for using equity release are to make home and/or garden improvements, treat or help family and friends, go on holiday and pay off debts, notably on credit cards and loans.

Just one per cent give reducing inheritance tax liability as a reason.

“Previously equity release was used predominantly to fund luxury purchases such as holidays and conservatories, now increasingly more customers wish to unlock the capital tied up in their property to supplement their retirement income,” says Vanessa Owen, Head of Annuities and Equity Release at LV=, formerly Liverpool Victoria.

It is certainly proving a popular way to boost annuity payments. The first three months of this year saw the largest amount of equity withdrawn since records began in 2002, according to the Equity Release Council. At £233.8m, this was 17 per cent higher than the same period last year.

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The number of plans rose three per cent. The average value over the same period increased from £49,069 to £55,985.

Equity release takes several forms:

n Lifetime or lump sum mortgage (33.5 per cent of the market);

n Drawdown mortgages, accounting for 65.9 per cent;

n Reversion (0.6 per cent).

A ‘lifetime’ mortgage pays either a lump sum or regular income. The money released plus interest is repaid when the property is sold. With ‘drawdown’, there is more flexibility as there is the option to release cash over time. A ‘reversion’ plan allows you to exchange the ownership of some or all of the property for a lump sum, thereby letting the provider benefit by its increasing value.

There can be confusion over an interest-only lifetime mortgage. This is where the homeowner makes regular payments to reduce the impact of releasing equity on the value of the estate. Some plans allow repayments that are equal to or less than the interest charged with the balance paid either from the estate or when the occupier moves into long-term care.

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The schemes on offer allow about one-third of a property value to be borrowed. With house price inflation, the current value may be far greater than the original price paid. Many retirees are living in an asset which has grown almost twice as fast as the average pensioner income over the last 15 years.

Unlike conventional mortgages, interest is not repaid monthly. Instead it rolls up and is added to the sum borrowed. This means the final debt may be substantial. If £50,000 is borrowed at a fixed 6.5 per cent, the debt will have reached £93,857 in a decade and a worrying £176,182 after 20 years.

The rise in lump sum policies is because customers wish to pay off existing debt, notably interest-only mortgages.

Fixed interest rates for life start from 5.5 per cent. Competition among providers, combined with cheaper wholesale funding sources, mean that a loan with rolled-up interest typically takes 11-14 years to double in size, compared to 10-11 years evident in plans offered just two years ago.

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Newer style interest-only plans with flexible repayment options allow greater choice than ever.

Always consult your family before making such a major financial decision, consider the alternative of down-sizing and involve an experienced financial adviser. The latter should know what incentives are on offer, notably free valuations as well as cashbacks (£1,000 is “common”, according to Simon Chalk, technical manager at Age Partnership in Leeds).

Watch for arrangement fees: £555 at Aviva, £495 at Holmesdale, £500 at Just Retirement, £695 with More2Life, £695-£750 at Newlife, £799 at Scottish, £650 at Stonehaven, nil with Bridgewater, Partnership Assurance and Vernon. The benefit in using drawdown over a lump sum scheme is that as only the money actually required is withdrawn, the interest charged is significantly lower.

Once the equity release agreement is in place, it creates a ‘cash reserve’ facility which can be called upon if and when a need arises.

The minimum age varies. As typical examples:

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n 55 years: Aviva, More2Life (some schemes at 60 and 70 years), Stonehaven.

n 60 years: Hodge Lifetime (but 65 years for reversion), Just Retirement, LV=, Newlife (65 for reversion), Partnership Assurance.

n 65 years: Bridgewater Equity Release, Scottish Building Society, Vernon Building Society.

n 75 years: Holmesdale Building Society.

Equity release is not right for everyone. It can have an adverse effect on eligibility for state benefits, on your tax position

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and certainly on the amount of inheritance you can expect to leave.

Watch for schemes where the interest is not fixed as the impact on your remaining portion of the property could erode drastically if rates are raised significantly.

Saga, for instance, which uses Just Retirement Solutions, will only recommend a plan with a fixed interest rate so that clients know exactly what will be owed.

Check, too, that the provider has a ‘no negative equity’ guarantee, meaning that as long as you adhere to the plan conditions, no debt will ever be left to your estate as a result of taking out the plan.

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Members of the Equity Release Council offer this guarantee. Holmesdale, Scottish and Vernon, all building societies, are not members.

Properties must be a minimum value to be considered, usually £70,000.

According to Moneyfacts research, higher levels are required by some providers, such as £80,000 (Vernon), £100,000 (Hodge Lifetime), £104,000 (Holmesdale) and £120,000 (Bridgewater).

The minimum advance is often 20 per cent or £10,000.

The maximum that can be borrowed can be the whole value (such as reversion plans with Bridgewater and Newlife) but more frequently 40-50 per cent of the valuation.