Equity Release Schemes - Do The Sums Really Add Up?

With the main concern over equity release schemes being the inheritance passed down to beneficiaries, here we discuss the pro's & con's of these lifetime roll-up mortgages.

Firstly, we look at the effect on beneficiaries & the sources of these areas of concern. This then leads us onto equity release calculations with facts & figures showing how these schemes fair for the beneficiaries at the end of the day.

Ok, we've have all heard the saying; bad news travels faster than good news & this is synonymous with term 'equity release'.

Although equity release plans originate back to 1965, the damaging news about them generally dates back to the late 1980's when 'home income plans' were initially launched.

Linked to an annuity or investment bond & an interest only mortgage, these plans were destined to fail, relying heavily on investment performance in a period of falling property values & rapidly rising interest rates.

The mid 90's then introduced the much derided shared appreciation mortgages (SAM's), the focus of most causes for campaigns against equity release including the Trevor MacDonald Tonight programme.

Is it any wonder reputation was soured?

So what has the equity release industry done about it?

At the time of the SAM's debacle, SHIP (Safe Home Income Plans) was launched.

Formed from its originators - Ecclesiastical Life, Hodge, Home & Capital Trust and GE Life all members agreed to abide by a strict code of conduct, which still exists to this day.

Soon, new lenders entered the market with household names such as Norwich Union & Northern Rock introducing the first roll-up schemes & bringing a significant boost & trust to the industry.

Although the volume of applications began to blossom around 2003 with 25,000 loans completed, a lack of regulation still overshadowed the equity release sector. The market was still somewhat blighted by its previous misdemeanours.

Thankfully, partial regulation was soon imposed on the industry with lifetime mortgages coming under the auspices of the Financial Services Authority on 31st October 2004. Home reversions joined lifetime mortgage schemes soon after & by 2007 full regulation & confidence was brought back to the sector.

Therefore, the market has evolved & strived to restore pride; a far cry from the negative perceptions of decades previous.

So what does this all mean for today's beneficiaries?

The main 'clean up act' came with the introduction of SHIP & its rules imposed on the members. The 'no negative equity guarantee' affords the greatest level of protection this industry can offer.

Safe in the knowledge that any amount borrowed by their parents can never escalate to more than the eventual sale price of the property, beneficiaries are at least guaranteed no debt can ever be passed onto themselves.

A crumb of comfort maybe, but peace of mind for the parents.

An equity release adviser should always encourage involvement of the heirs to the estate. WithOnline Equity Release Wandsworth& assurance, feelings can then be vented either for or against equity release being taken as for many elderly people this is a major financial proposition.

Again qualified advisers should play an important role in explaining the pro's & cons of lifetime mortgages & convey these issues to all parties concerned.

What else does the equity release sector afford by way of protection?

Interest rates for home equity release schemes, albeit not the lowest ever, are still historically low. One positive feature of these schemes is the lifetime fixed rate on all loans now.

So what is the benefit of this?

If you borrowed an amount of capital, with a fixed interest rate for life it enables you to calculate the exact future balance.

This is building further reassurance for potential mortgage applicants.

A client will always be made aware that the equity release balance escalates over the lifetime of the scheme; this is the nature of these plans & should never be entered into unless this has been clearly explained. The effect of the interest compounding annually, approximately doubles the balance every 10-11 years, depending on interest rate charged by the equity release companies.

Sounds daunting? Well, let's now look at the sums as promised:

One of the lowest interest rates around at present would be the Aviva Lifetime Lump Sum plan, which at the time of writing this article has a fixed lifetime interest rate of 6.65% (6.9% APR) annual.

A male, aged 65 borrowing a lump sum of 25,000 on the Aviva Lifestyle lump sum at a fixed interest rate of 6.65% would know exactly what the future balance will be, even before taking out the equity release scheme. The Key Facts Illustration provided by the equity release adviser will confirm these figures & also the costs & additional features involved.

For instance, given the aforementioned figures at the end of 10 years the mortgage balance would be 47,594 & after 20 years it would be 90,606.

This may seem expensive given only 25,000 was borrowed initially; however there are two factors that could still rule in favour of the a lifetime mortgage scheme.

One common issue overlooked is the potential for property values to increase. If so, & with 100% ownership of the house still being retained, then the homeowner will fully benefit from any escalation in the house price. This will then offset some of the compounding effect of the interest & mitigate its effect on the estate somewhat. Again, we are looking here at the longer term & no guarantee can be given they will go up; nevertheless historical records show they have indeed.

Consequently, a rule of thumb is never to borrow anymore than required beyond the initial 12 months. Plans are now flexible enough & with drawdown equity release schemes introduced & now being the most popular roll up lifetime mortgage, then the funds can be drip fed over time as & when required.

Additionally, by taking a lower initial amount, results in less interest being charged, thus meaning more inheritance passed onto the beneficiaries.

The second factor affecting the balance accruing & is also the primary cause of roll-up & that is purely down to the fact that NO monthly payments are required. This helps retirees to have access to the some of the equity tied up in their property & at the same time having NO effect on their budget.

Finally, equity release schemes do have an ever increasing part to play in the retirement planning for the over 55's. Care must always be taken & should never rushed into without discussion & involvement of third parties. Advice should always be provided by an industry qualified equity release consultant.

Hopefully lessons have now been learned from the past & the industry can move forward, innovate & develop further over time. If so, & in the right circumstances equity release can provide for many, a comfortable & enjoyable retirement.