Equity release could have a greater part to play in how people finance their retirements in the future.
Pension freedoms introduced on 6 April this year could end up enticing people to spend their pensions faster than they mean to.
While, many haven’t actually saved enough into their pensions to even enjoy these greater freedoms and are facing an income shortfall in retirement. Their property may be the only valuable asset they have.
Releasing money locked in a home is a viable option for cash poor, asset rich people in retirement, and the advisers we speak to see equity release as a growth area for their future business, to meet the needs of an ageing population.
However, there still seems to be some confusion relating to equity release, particularly around whether you need to be licensed to offer the product to clients.
What is equity release?
Equity release is designed for those aged 55 and over, who own their property, are asset-rich and want to access this wealth in a flexible way without having to sell the property and move.
Typically lifetime mortgage loans to value start from 19% at 55 years old and increase roughly 1% every year until the maximum 50%.
Customers can take from £10,000 up to the maximum allowance and anywhere in between. They don’t need to take the full amount in one go, instead they set up a reserve facility to draw down from, only accruing interest when the money is taken.
Is there interest to pay?
Yes, there is interest to pay on the borrowings. When you draw the funds, you are given a fixed rate for the lifetime of the mortgage. Interest rates are at the lowest they have been in years, with the current headline rate at 5.05% at the time of print.
How is the interest paid?
Clients have a few options when it comes to paying the interest:
Let the interest roll-up and pay back in one lump sum, either when you sell the property, repay early through other funds or your estate sells the property when you pass away.
Make flexible payments, up to 10% of the initial advance every year in a maximum of 4 instalments. With this option, you are not committing to making payments so it falls outside of the Mortgage Market Review affordability criterion.
Commit to making monthly interest payments – this can be anything from £25 per month to 100% of the interest. With this option, proving affordability can be a barrier.
Is there a term?
The clue is in the name lifetime, it is designed to run for the lifetime of the borrower. This is a significant feature in an environment where extending a mortgage term into retirement is very difficult.
The mortgages can be paid back early though some may come with an early repayment charge.
Others offer ‘downsizing protection’ where a customer is able to downsize later, clearing the mortgage as they do so without penalty.
This feature is popular among younger customers who may have cash requirements now but feel their home is not one they see spending their whole retirement in.
Equity release has ‘come a long way’
The lifetime mortgage market is in a sustained growth period, with £1.4billion sales in 2014 up 49% on 2012 . The market is expected to reach £2billion by 2016 as a result of product innovation, more widespread demand and demographics.
Legal & General recently announced their entry into the marketplace to complement the incumbent insurance giants Aviva and LV=. We expect more FTSE entrants into the marketplace in 2016.
Who is releasing equity?
Contrary to popular belief, lifetime mortgages are definitely not a last resort product for the needy or those who haven’t planned for retirement.
The financially astute and savvy top the ‘propensity to buy’ indices – those with above average property wealth and a history of purchasing financial products.
Recent research by KPMG predicted the UK average property size should be £900,000 by 2034. The people who are buying lifetime mortgages are acutely aware of their property wealth and want a way to access a portion of it.
They see their property as part of their wealth portfolio like their pension and savings are.
The average UK home increased in value by 11% between 2013-2014. In the same period, the average retirement income only increased by 3.27%.
We are seeing an increasing number of high-net-worth clients turning to equity release. We expect this area to grow exponentially now that new pension freedoms mean that pensions can be passed on tax-free in certain circumstances.
In this instance, we expect more HNW clients to look to draw income from their property wealth with an intention of leaving their pension wealth to their estate. Pensions will become a very tax-efficient way of cascading wealth through generations, whereas property remains subject to inheritance tax.
The effect is compounded with the reduction of the lifetime allowance to £1million by 6 April 2016. There are significant tax implications for those HNW clients that want to maintain a high standard of living over and above the income that a £1million pension can provide. Property wealth could be the answer in these situations.
Do I need to be licensed to get involved?
You don’t need to be licensed to have discussions with your clients and then refer interested parties to a company that specialises in lifetime mortgages.
The Financial Conduct Authority actively discourage dabblers in this marketplace as it takes familiarity and regularity to maintain the standard of advice required, especially as the marketplace is moving so fast with new products and lenders.
We’re finding many advisers are fielding calls from their clients about these products. It pays, therefore, to be prepared with the information and a route to place the business.
Steve Wilkie is managing director of equity release provider Responsible Equity Release