This week’s podcast is all about equity release and making partial payments. Craig Skelton is joined by Equity Release Specialist, Mark Thompson.
How does equity release work?
Equity release is often called a Lifetime Mortgage – a mortgage fixed for life. It’s a fixed rate mortgage, with a fixed rate percentage term, that’s repayable upon death or going into long term care.
If one of you dies or goes into long term care, the other one can still remain in the house. When the second person dies or goes into long term care, the mortgage has to be repaid.
The mortgage repaid is the amount you borrowed plus any interest that you owe at the time. As we’ve talked about before, the interesting thing about a lifetime mortgage is that you don’t have to make any payments.
If you borrow £100,000, yes, you could pay the interest on £100,000 and after ten years, you still only owe £100,000 because you’ve paid interest off. But you don’t have to make any payments. If you choose not to, the interest due on the £100,000 is added each year, then the next year you pay interest on the higher sum. That means the interest compounds up.
This is what some people don’t like about equity release products – the thought of paying interest on interest.
Can you give an example of how that works?
It all depends on how much you’re borrowing against the value of your home. As an example, two people who are exactly the same age could be paying different rates of interest – because one party is borrowing a lot more against the value of the home. It means they have a higher ‘loan to value’.
If you have a £200,000 house and you want to borrow £100,000, that’s a 50% loan to value. The more you borrow, the higher the rate is – because there’s more risk. The mortgage provider is giving you a loan where you don’t have to pay a penny back for decades. That’s a significant risk to them.
The longer you live, without making any payments, the amount of money you owe increases. There’s a risk that what you owe will become equal to the value of the house, or even more. But you also choose to ‘service’ the loan – i.e. make payments against the interest that you owe. The Equity Release Council, which is a consumer trade body, has just announced a new product standard. It means that everybody has the right to make non-penalised payments against their loan to manage the interest.
So if you make partial repayments, is that penalty-free?
With a standard residential mortgage, you can repay up to 10% of the loan without having any penalties. But with equity release it’s a little more complicated.
With a standard residential mortgage, if I were well enough off to do it, I could pay 10% off my mortgage each year and reduce the amount owing very quickly. When it comes to lifetime mortgages, you can service the interest or service the loan – but you can’t do both. You can pay off the interest, or you can make up to a 10% annual repayment with equity products.
With one large lifetime mortgage provider, if you borrowed £100,000, you could service the interest each month so at the end of that year, you still owe £100,000. There’s no charge for you to do that. You could do it over ten years, and at the end you still owe £100,000 because you’ve paid the interest.
What this provider won’t allow you to do, unlike with a standard mortgage, is pay off an extra 10% on top without penalty. Obviously, this is how they make their money. Bear in mind that these providers are allocating money to you for 25, 30 years at rates as low as 2.5%. They’ve got to make a profit somehow.
Meanwhile, there are other providers who don’t want you to pay the interest, but allow you to pay up to 10% each year without any penalty. If you borrow £100,000, they’ll let you pay £10,000 a year, penalty-free off the mortgage.
What if I don’t want to pay anything back?
Not everybody wants to save interest costs. It depends upon your situation and why you need your borrowing.
I just had a phone call with a client who has three children. She says, “I’ll never give up being a mum and far as I’m concerned, I want to leave them as much as I can.” So she’s going to pay some interest off or service the loan to maximise the estate for her children.
Meanwhile other people’s children are doing well – or perhaps the clients don’t have any children. So why worry about paying the loan back? They might as well enjoy the money – who wants to be the richest person in the graveyard?
How do I decide what’s best?
As we always say, equity release is not for everybody. It’s down to you and your personal situation. And in the same way, for some people it’s important to pay the interest back – but for others, it’s not.
That’s why it’s so important to speak to a specialist. Not a salesperson – we don’t have those here. We will sit down with a client to understand their situation and what they’re looking to do. And we will tell them whether equity release is right or not for them.
A trained, qualified advisor will spend an hour and a half, sometimes two hours, understanding each client. We’re the best people to help you make an informed decision.
This area is heavily regulated by the FCA and the Equity Release Council. People that don’t need equity release often don’t understand it and yet will tell others not to do it. But there are 600+ products out there, tailormade to certain people’s needs. There’s never a one-size-fits-all.
How important is the interest rate?
It’s always an individual situation. I have one client paying 2.82% fixed for life, and one is paying 5.61% fixed for life. That’s double what the first person is paying. But both of those situations are ideally suited to each client. They’re both absolutely ecstatic that they’ve got that product set up at that rate, as it was the only option that allowed them to achieve what they wanted.
Somebody might say to the man who’s paying 5.61%, that’s ludicrous. Why are you paying so much… but he would explain that he had an interest-free mortgage that he had to pay off, otherwise he was out of his house with nowhere to go. Now he has a mortgage at 5.61% that he won’t have to pay back if he doesn’t want to, and can stay in his house for the rest of his life.
Meanwhile the client at 2.82% bought a house he previously didn’t think he could afford – and he’s absolutely ecstatic.
Just to give you an example, with £50,000 borrowing at 2.82% if he makes no payments whatsoever, his interests compound up and he owes £76,489 after 15 years. So the debt has gone up by just over half in that timeframe.
But how much is that property going to go up by? Average property prices have gone up by £20,000 just in the last few months. I’m not suggesting you rely on property price inflation – you should never do that. I would usually forecast growth at 1% a year, 2% at most.
Every client of mine will see a full set of information and graphs explaining your house price, the loan, the interest rate. If you don’t pay anything back, this is how it’s going to be impacted over the next 15 to 25 years. So they can see with their own eyes exactly where they’re going to be if they choose not to make payments.
Why do people say equity release is a bad idea?
Somebody that’s looking at stories in the media from 30 years ago would probably advise you not to do it. But even so, why would you not just evaluate the options?
I had a client whose financial advisor told them not to take equity release. I offered to talk to the financial advisor. When I called him, he admitted he didn’t really understand equity release. Once I went through all the details with him, he said: “Well, that’s a good product, isn’t it?”
What other advice do you have on equity release?
Equity release certainly isn’t right for everybody. But for some, it’s the right option – and sometimes the only option. It can be the difference that means not selling your house, moving into rented accommodation, or paying off an interest only mortgage.
If you walk away and then rent for the next couple of decades, how will you pay overall in rent? For some people, equity release is a way to hold on to your main capital investment that technically could be making you money. Once you’ve sold that property, you have less invested in the property market. If you still own a home that’s going up in value, you’re technically still in control of your own finances.
Once you go into rented accommodation you’re at the mercy of a landlord who might decide to sell your home at any point.
It’s very difficult to explain the concept of compound interest in a few minutes, and how it impacts a client’s situation in real life. In reality, I sit with a client and spend time making sure that they understand what it is and how it works. We go through real examples and explore how they feel. That way people reach their own decision.