Risks of Equity Release
You might think the major risk is the loss of your home, though some plans now will guarantee that you will never be asked to leave your home or the right to live in your property if you wish. However, the higher the amount of cash you release, the greater the potential threat to your means-tested benefits. Many people use additional cash to improve their quality of life, often by paying for services or purchasing items that will enhance their daily living. You should consider whether, at a future date, you will be able to continue paying for these things from your regular income, or whether the extra spending will be absorbed into your general standard of living. Often the loss of an entitlement to means-tested benefits become apparent only at a time of crisis or emergency, when additional income is required, for example on entering a care home. You should bear in mind that improving the quality of life in this way may involve an increase in regular outgoings, and a corresponding reduction in capital or income limits for some means-tested benefits. A person’s health can change unpredictably and sometimes the best option is to have the value of your home disregarded when assessing eligibility for benefits so that you can receive extra help without having to consider selling your home. This is no longer possible once equity has been released from your property.
Another extremely common and often long-term use of released equity is to help children or sometimes grandchildren financially, usually by providing an early inheritance. This can have negative consequences if the money is raised using a re-mortgage or secured loan, as the children may find that they eventually receive less from the remainder of the estate. It can be difficult to weigh up the advantages of helping family members at a time when you can more readily afford it, with the disadvantage of a potential reduction in your own standard of living at a time when you may have higher care needs or medical expenses.
Compound Interest
This is why the taking of compound interest lifetime mortgages can take away financial freedom from those in old age who have means-tested state benefits.
If you were then to purchase a deferred care annuity at age 74 with the remaining £37,500, the annuity may not cover the cost of care, and you would not be able to use means-tested state benefits. The annuity may not even fully cover the cost of care, and should the money run out, you would need to end the annuity. At this point, the annuity income is considered capital, and should you give up the annuity, you may be unable to retain means-tested benefits.
For instance, let’s say you released £50,000 as a mortgage and a further £50,000 which you invested in a savings account. Should you need to move to long-term care after 5 years and had accrued an interest of £50,000, you would sell your home and pay off the £100,000 debt. However, the investment would have accrued interest too, and with a 5% interest rate, it would amount to £62,500.
Compound interest is interest that is added to the capital so that the interest also earns interest. It can be thought of as interest on interest. Although this will benefit you if you have a lifetime mortgage, it can mean that the amount you owe will quickly grow and can cause an issue for those who were considering releasing equity from a home that they would like to leave as an inheritance.
To counter compound interest it is always best to consider making a payment each month to counter compound interest. It is advisable to seek independent financial advice to avoid significant financial difficulties in the future. Compound interest is a fundamental concept to understand when considering the long-term implications of equity release.
Potential Threat to Means Tested Benefits
In Scenario A, Mrs J takes out an equity release scheme which enables her to release £3000 in the first year, and a further £7,000 in the fifth year. She uses the money to increase her income each year for the first £3,000 per year to the income support level, to clear her bank loan, and then in the fifth year she buys a new fridge and freezer. At that time, her total income increases to £12,000 per year.
Mrs J is 69, a widow, and lives alone in her home in a London suburb. She is about to retire from her part-time job and has a total income of £150 per week. She has a bank loan which she is repaying at £30 per month, and she is in good health.
Benefits of Equity Release
An equity release mortgage, which allows you the option of taking further releases in the future. In these cases, it is important that the lifetime mortgage or home reversion provider offers the facility for further advances. By doing so, it can save on the disturbances of setting up alternative plans later in retirement, whilst enabling you to safeguard some of the inheritance for the children earlier. This is because the initial release will hopefully serve its purpose with there being no further impact upon the next generation’s finances.
The basic loan attracts an interest cost, although the funds may not be immediately required. It is pointed out that using an equity release scheme can defer the requirement for drawing capital from other investments until such time as the lump sum is required for personal or health reasons. Therefore, the ability to only attract interest on the initial funds released makes equity release a more cost-effective approach to debt consolidation. This is an important point to make in future years as always, the debts taken are likely to be repaid upon death or moving into long-term care. In which case, it will be necessary to then buy back into the open market another financial product. This could be difficult in terms of mortgage rates continually rising and providing uncompetitive terms for people in older age groups.
Access to Lump Sum
Lump sum plans are designed for homeowners who want to take their tax-free cash in one go. They allow you to borrow a one-off lump sum with interest added on an ad-hoc basis, helping you to preserve the value of your inheritance. Because you only pay interest on the amount you’ve borrowed, these can be cost-effective ways to ring-fence an inheritance. By setting up a lifetime mortgage with a fixed interest rate, you can ensure that the amount of equity you leave behind does not decrease. However, the most popular method to get the lump sum is the drawdown scheme. This is a more flexible, low-interest way of borrowing money for the long term. You take the money in ‘drawdowns’ as and when you need it and only pay interest on the amount you have taken, as opposed to the value of the whole loan. Usually, there will be an initial lump sum with an added facility to take further cash sums. Sometimes these are agreed upon at predetermined future dates and can also be arranged very quickly in response to unforeseen needs for cash. This method can also sometimes include a higher loan-to-property value ratio and/or lower early repayment charge, but it is worth investigating each individual scheme to determine its cost-effectiveness.
One main benefit of equity release is the access to a cash lump sum. It is a commonly known policy among retirees to have a good amount of money saved in the form of housing assets. However, it is in a non-liquid form and therefore the only way of releasing the cash value is by selling the house and moving to a smaller property or even to a rented accommodation. Neither of these are ideal solutions as moving home can be a very stressful experience which can also involve large costs such as estate agent fees, stamp duty, legal costs, and removal expenses. If the alternative is moving to a rented property, this may give a feeling of insecurity due to short hold tenancies or long-term leases plus the fact that the property does not belong to the retiree. By taking out equity release, it can enable the homeowner to maintain the current lifestyle without change and still live in the same property and even generate extra cash to perhaps help family in the form of early inheritance, school fees assistance, or to improve their standard of living.
Flexibility in Using the Released Equity
Flexibility in how released money can be used is a key attraction. While some people have definite plans for how they want to spend the money, many do not. A survey for SHIP found that only 56% of people spending funds from the typical lifetime mortgage had known how they wanted to use the money when they took the loan, compared with 76% who were already homeowners when it was taken. (There is some overlap between the two groups). Of those with plans, home improvements were the most popular single category, cited by 30%, followed by holidays/travel (17%) and buying a new car (15%). But the money is used for a very wide range of other purposes. It can be to help children (or sometimes grandchildren) at times of financial need, perhaps with house deposits, or to avoid or reduce the inheritance tax liability on their own eventual inheritance, often by making gifts. In other cases, it can be to supplement retirement income, e.g., to cover regular insurance premiums, or for specific one-off expenditures such as a family wedding. All of these are legitimate uses of the money, but individuals’ priorities and needs can change, and what might seem a good idea at the time when the equity release plan is taken may no longer be the case as circumstances change.
The fact that interest is only payable on the released money as it is drawn, for future use, helps to address this issue of changing needs. The money is typically released in a series of instalments over time rather than all at once. The longer the time over which it is taken, the lower the cost, as the total interest payable will be greater the longer the period for which the loan continues. A partial exception to this is home reversion, where the no-interest loans are typically converted into annuities which do not reflect changing interest rates and are generally less costly the older the annuitant is. In some cases, particularly lifetime mortgages, people may take more money than they need at the time. This can be to avoid using up savings to cover regular income shortfalls, bearing in mind that savings can be run down at any future time to reduce or repay a mortgage. It can also be to provide a ‘buffer’ of extra money for future unforeseen needs or anticipated later life expenditure such as care costs. Interest on any money which is not initially taken does not accrue until it is drawn, so the total cost of the loan will be less than if additional borrowing was taken at the time the future needs arise. The option of further borrowing of additional money at a later date (provided that schemes are still available) can be more costly, depending on future interest rates and the availability of suitable schemes at the time.
No Monthly Repayments
A lifetime mortgage can help those who are asset-rich but cash-poor to solve this dilemma, allowing them to release equity from their home without having to move out. While the benefits of releasing equity are clear, with a lifetime mortgage there is nevertheless a major incentive to completely clear the debt one day. Personal circumstances could change, and depending on income and lifestyle in retirement, people may not want to be burdened with mortgage repayments in the future. They might also wish to protect, where possible, some of the inheritance they hope to leave for their children. Lifetime mortgages trade off monthly repayment for interest rolling up. With a lifetime mortgage, there are no required repayments, as the interest can be added to the loan and repaid at the end of the plan. This simplifies the mortgage and avoids any adverse effect on monthly cash and standard of living. It also provides a high degree of flexibility; people can switch back to a capital repayment mortgage at any time, paying off interest and preventing the build-up of debt, or can repay some or all of the interest each year to stop it accumulating. The no-repayment approach is especially beneficial in cases where one person’s spouse is in care. In this situation, the spouse can continue to live in the home and avoid an unsolicited house sale to cover care costs.
Options for Managing the Equity Release Loan
In a worst-case scenario, lifetime mortgage and home reversion customers could be forced into selling the property when the customer is in very poor health and it is difficult to find an appropriate buyer, usually resulting in a poor sale price. This is because those schemes are non-standard loans secured on the property so there is no absolute right to reside in the property regardless of the health of the borrower. It will usually be in this situation that the customer and family decide that it is best to give up the right to the property and move into more suitable rented accommodation, or to release it and sell a home reversion property. At this stage, or if the customer is in poor health but still wishes to remain in the property until their death, advice should be sought from an attorney or welfare deputy, as depending on the nature and severity of the health condition it could be very much in the interests of the customer to terminate the equity release scheme but they may not be mentally capable of making that decision in future.
The issue must be examined both from the point of view of the customer and from the rest of the family. Usually, the customer will wish to remain in the property until their death, as they regard it as their home and the best place to receive visits from and provide support to family members. This is best done if the equity release scheme has a “no negative equity guarantee” so that no matter how large the accrued debt in future, the customer will never be forced to move house. However, many elderly people do not have the financial, physical, or mental capability to remain in their own homes when they reach a certain stage of increasing dependency. At this point, continuing to retain the property may be of little benefit to the customer and more a burden to family members who are tasked with the responsibility of future maintenance and insurance of the property.
This section deserves individual attention because of the complex choices available to customers and their families. It is impossible to generalise about the best course of action in any circumstance, as to how an equity release loan should be managed when the last surviving customer moves into long-term care, because of the differing needs, financial and personal, of each family. In all cases professional advice should be sought from a suitably qualified financial adviser and from an attorney or welfare deputy.
What Happens When Equity Release Customers Move into Permanent Care
A regulated equity release sale occurs when the customer (or last surviving partner if a joint application) has moved out of the property and into long-term care, and they are unlikely to return to the property. It would also occur in the event of death. The loan and interest are then repaid in full. This is done without any penalty and within the 8% maximum early repayment charge (ERC). In this situation, it is imperative that the equity release company is informed immediately, as leaving it too late may result in significant financial detriment to the estate, due to the charges involved with a lifetime mortgage discussed here.
When an equity release customer moves into permanent care, the first thing they or their attorney must do is inform the loan provider. This triggers the start of the process which will eventually lead to the loan being repaid. The customer no longer has to make repayments on their loan until the property is sold. However, it is still recommended that they keep the interest rolling up under review, as the impact of doing this can still have a significant effect on the ultimate extent of the inheritance they leave.
Repayment of Equity Release Loan
With a Home Reversion plan, if the homeowner wishes to repay the loan early and retain the property, the property will be sold for the initial loan amount, plus a percentage of any increase in the property’s value. This is also known as a rebate and is becoming increasingly expensive as property prices continue to rise. If there is not already a clause allowing early repayment at today’s prices, it may be possible to negotiate with the provider. However, it could be costly and prohibitive in practice.
If a home reversion plan was taken out, the property is sold, and the provider receives the same percentage of the property’s value as was agreed at the outset. Any remaining monies from the sale are distributed according to the homeowner’s will. This means there is a guaranteed inheritance for the homeowner’s beneficiaries, as the value of the percentage of the property’s final sale value will have already been calculated.
When the plan ends due to death or moving into long-term care, the property is sold, usually through an estate agent. The sale of the property settles the equity release provider’s debt, with the remaining monies from the sale being distributed in accordance with the homeowner’s will. There are two types of equity release plans, and they are treated differently upon death or moving into care.
Distribution of Assets
As regards the distribution of assets, the legal position has historically caused significant concern. It has been observed that a home reversion plan, which entails the sale of a portion of a property, can potentially result in the individual transferring a share in the property for a sum that is lower than its actual value. This situation may lead to unfairness and disadvantage for the individuals who are entitled to the remaining portion of the property upon the holder’s death. Previously, if the plan holder passed away before the surviving joint owner of the reversion, not all of their interest would be transferred to the surviving joint tenant due to the nature of joint tenancy, which involves the right of survivorship. This inconsistency has fortunately been addressed and rectified through the implementation of a specific provision.
What Happens When Equity Release Customers Die
If the property is to be sold, the equity release provider must be notified and they will be given the opportunity to repay the loan in full, without incurring any early repayment charges. This would be done using the cash from the sale of the property and if there is any money remaining, it would be distributed amongst the beneficiaries. If the full amount required to repay the loan is greater than the sale price of the property, there is a no negative equity guarantee on all SHIP schemes and so the beneficiaries are not liable for any amount over the sale value of the house. Any outstanding amount is purely a loss to the equity release provider.
In the event of the death of someone with an equity release plan, action needs to be taken in order to establish the wishes of the beneficiaries and what they would like to do with the property. The home reversion plan will already have joint legal ownership of the property and so no action needs to be taken if the surviving partner wishes to continue living there.
As with most forms of lifetime mortgage, the property (that is, the equity release customer’s home) is the only security used for the equity release loan and it cannot be repossessed at any time other than following the death of the last surviving partner or when moving into long-term care.
When a person dies, their property passes to their beneficiaries who will seek to distribute the estate. This process is often quick but could take some time if the deceased’s financial situation is complicated or if there are any disputes between the beneficiaries.
Equity release refers to schemes available to older homeowners (55+) who have taken some cash from the value of their home. The schemes provide a way for releasing the equity (money) tied up in your home, providing a cash lump sum or a steady stream of income. You can get advice about which equity release scheme may be right for you.
Impact on Care Costs and Funding
The ageing of the population has profound implications. Not only will the numbers of elderly people increase, but their share of the total population will increase. This has led to increased concern from the government over how this care will be provided and funded. Care provided to elderly people is divided into three main categories: care in the community, provided in the client’s own home by a social service or healthcare worker; residential care, where the elderly person lives in a care home and the home provides a 24-hour support service and nursing care; and intermediate care, which is provided within the NHS and is a short-term service to help elderly people either to be discharged from the hospital or to prevent them from having to go into the hospital or care home. Community care will be affected by the introduction of means testing for care services, in the form of the Health and Social Services and Social Services (Community Care Resources) (Amendment) (Wales) Regulations 2002. This means that any elderly person with income or savings above the upper capital limit will have to pay for some or all their care at home (Wales). This has led to the finding that an increasing number of elderly people are releasing equity from their homes to pay for these care costs. This raises the question of whether it is the most efficient method for older people to pay for care costs and what the long-term implications are for them.
iii) Impacts and Implications of Equity Release on Care Costs and Funding
In conclusion, retired persons contemplating fundraising from their property, must recognise the significance of seeking independent advice. To help navigate this complex financial landscape effectively. Whether considering downsizing, equity release, or renting out property, retirees must weigh the benefits and risks of each option in light of their individual circumstances and goals.
Independent advisers play a crucial role in providing retirees with the expertise, perspective, and guidance. The information that is needed to help you make informed decisions and secure your financial well-being in retirement.
By leveraging independent advice, you can confidently navigate the process of raising funds from your property. But there are no guarantees that you will be able to do so. as everything is subject to your circumstances. And ensuring the decisions you may make enhance your retirement lifestyle. And safeguard your financial security for the years ahead.
