Equity release

Equity release is a means of retaining use of a house or other object which has capital value, while also obtaining a lump sum or a steady stream of income, using the value of the house.

The "catch" is that the income-provider must be repaid at a later stage, usually when the homeowner dies. Thus equity release is particularly useful for elderly persons who do not intend or are not able to leave a large estate for their heirs when they die. The reverse mortgage is a form of equity release that is available in Australia, Canada, the United States and the United Kingdom.

Types of arrangement
  • Lifetime mortgage: A loan secured on the borrower's home (a mortgage loan) is made. Compounded interest is added to the capital throughout the term of the loan, which is then repaid by selling the property when the borrower (or borrowing couple) dies or moves out (perhaps into a care home). The borrower retains legal title to the home whilst living in it, and also retains the responsibilities and costs of ownership.
  • Interest only: A mortgage is made, on which the capital is repaid on death. Interest payments are paid whilst the borrowers remain in the property.
  • Retirement Interest Only Mortgage (RIO's): Introduced in March 2018, RIO mortgages have been granted permissions by the FCA. RIO's start from age 55 and are based on income and affordability of the homeowner with just the interest-only element being paid each month. They run over an individuals lifetime (rather than a specific term) and only need repaying once the property is sold, usually on death or moving into long term care.
  • Home reversion: The borrowers sell all or part of their home to a third party, normally a reversion company or individual. This means all or part of their home belongs to somebody else. In return, the borrowers receive a regular income or cash lump sum (or both) and they continue to live in their home for as long as they wish.
  • Shared appreciation mortgage: The lender loans the borrower a capital sum in return for a share of the future increase in the growth of the property value. The borrowers retain the right to live in the property until death. The older the client the smaller the share required by the lender. This type of arrangement is no longer available in the UK.
  • Home income plan: A lifetime mortgage where the capital is used to provide an income by purchasing an annuity often provided by the lender, which is often an insurance company.
  • UK Equity Release Schemes: Generally available to over 55 year homeowners with sufficient equity in their property, who can opt to release some of the capital from their homes via an equity release arrangement from specialists lenders.

Advantages
  • It can provide a lump-sum of tax-free cash or a steady income (annuity), which can be index-linked, for the rest of your life.
  • It can reduce the amount of inheritance tax paid by your estate.
  • The no negative equity guarantee (NNEG) protects the borrower in the event of a downturn in the housing market.
  • If interest rates fall, borrowers are free to refinance their mortgages at a lower cost with other providers.
  • It is possible for the client to stay in their home and not have to make repayments during their lifetime.

Disadvantages
  • It may decrease the amount of money your family will inherit upon your death - assuming the value of the property grows at a slower pace than the interest rate on the mortgage.
  • It may reduce the amount that you can bequeath to charity.
  • In the UK, it may impact any means-tested benefits that the borrower may be entitled to.
  • It's far more expensive than selling the property to release equity

United Kingdom

The UK equity release market is basically made up of two types of equity release plan. The most popular plan is a lifetime mortgage - where the homeowner retains ownership of the property but the property is charged with the repayment of a loan or mortgage, which accrues rolled-up interest over the period of the homeowner's lifetime. To help customers decide whether equity release is right for them, a number of companies provide a free equity release calculator to show a rough estimate of the amount of equity that could be released.

The other type of plan is a reversion plan - where the homeowner sells all or part of the property to the equity release provider in return for a right to remain there rent free.

The UK equity release market is now fully regulated. Both lifetime mortgages and home reversion plans now fall under the remit of the Financial Conduct Authority (FCA). Prior to FCA regulation, many lenders signed up to Equity Release Council (ERC) formerly known as Safe Home Income Plans (SHIP), a voluntary code of conduct that provides a number of guarantees.

ERC was formed in 1991 in an attempt to improve the equity release market and its previous poor reputation. The ERC guarantees include a guaranteed right to remain living in the property which is the subject of the equity release, either for life or until entry into long term care. In addition, there is a vital No Negative Equity Guarantee - which essentially guarantees that the amount to repay the equity release plan on death or entry into long term care can never exceed the value of the property itself, and so no debt can ever be left behind for beneficiaries of the equity release borrower. In 2012, SHIP rebranded as the Equity Release Council (ERC) and extended its reach to Equity Release advisers as well as product providers.

The current members of ERC include Aviva, Bridgewater, Key Retirement, Bower (formerly Bower Retirement), Hodge Lifetime, Just Retirement, LV=, More 2 Life, Legal & General Home Finance (formerly New Life), Retirement Plus, One Family, Equity Release Supermarket, Responsible Lending, Responsible Life, Canada Life (formerly Stonehaven and then Retirement Advantage) and Pure Retirement.

Whilst a number of equity release providers, most notably Prudential, exited the market in the wake of the Credit Crunch, this trend has been reversed since the end of 2010, with a number of these companies - including More 2 Life, New Life and Stonehaven - keen to attract new customers once again.

In 2010, £910.6 million of equity was released by UK home owners using regulated equity release with this rising year on year to £1.38 billion in 2014.[1][2]

By 2017, the equity release industry had grown significantly, with over £3.06 billion of lending.[3]

In 2018, Retirement Advantage was acquired by Canada Life and Responsible Lending entered the market.

Pricing of no negative equity guarantee

The UK Prudential Regulation Authority expressed concerns in 2018 that firms investing in ERMs should 'properly reflect' the cost of the no-negative-equity guarantee. Its consultation paper CP 13/18, published 2 July 2018, provided a benchmark for valuing the guarantee. The paper recommended modelling the guarantee as a series of put options expiring at each period in which cash flows could mature, weighted by the probability of mortality, morbidity and pre-payment, using a version of the Black–Scholes pricing formula. It recommended that the underlying price of the option should reflect the cost of deferred possession of the property, independent of any assumptions about future property growth, warning that many of the approaches presented to it implicitly assumed negative deferment rates.[4]

United States
Main article: Reverse mortgage

See also

Notes
  1. Equity Release 2010 Annual Market Report Key
  2. Equity Release 2014 Annual Market Report Key
  3. "Equity release records broken as unprecedented Q4 activity sees 2017 lending reach £3.06bn with annual growth at a 15-year high". Equity Release Council. 2018-01-23. Retrieved 2018-08-05.
  4. "Consultation Paper CP 13/18" (PDF). Bank of England. 2 July 2018. Retrieved 5 August 2018.
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