FOOL'S EYE VIEW
Releasing Cash From Your Home

By Stuart Watson (TMFTiger)
March 19, 2002

Carburton Street, London -- We're likely to hear a lot more about equity release schemes in the next few years. One of the consequences of the current pensions 'crisis' is that many people approaching retirement are likely to have a significant portion of their wealth tied up in their home, having paid off their mortgages in full. However, a lack of other assets and incomes means that many will not have sufficient money to live the life they want, or are used, to.

So, what are these schemes and are they worth considering if you find yourself in the position of being 'asset rich but income poor'?

What Are They?

The term actually covers a wide variety of products but there are two main types. The first are reversion plans. Here, you agree to sell all or part of your home to another party. When you move home or pass on, they then take their share of the proceeds. The main disadvantage with these schemes is that you will have to suffer a substantial discount from the actual market value. In fact, it is estimated you will only get between 35% and 60% of actual market value in most cases, as well as missing out on future capital appreciation. It's clear that this is not a cost-effective option.

The second type is the rolled-up loan. You receive the value of the loan (which you can take as either capital or income) and the interest you would normally pay is rolled up year after year. The loan plus the interest is then repaid when you move house or pass on. Here, the disadvantage is that the loan plus interest may roll up to such an extent that it could even exceed the value of your home. Many plans now guarantee that you will never be forced out your home and offer fixed or capped rates of interest. The rates are, of course, higher than you would get with an ordinary mortgage because the lender is more restricted in the security they have over the property and their money is tied up for an uncertain length of time.

What Are The Main Problems?

There is a definite stigma attached to this sort of product fuelled by misselling of similar plans in the 1980s that were also tied to investment schemes. As with many mixed products, they were poorly explained and were usually just an excuse to hide high charges.

The current products are still tough to get your head around and the whole area is a definite target for those of a less ethcial persuasion. Many of these products still fall between the gaps of regulation for mortgages and consumer credit. Last July the FSA said it was planning to release a report on this area within the next 12 months, but this is yet to hit the streets.

We also like the comfort that owning our own home, without any mortgage, gives. Giving it all up, or even part of it, is perceived a big step backwards. We also feel that our home is something we should be able to pass on. It's reckoned that about three-quarters of those aged 65-69 own their own property and 85% of these own the property outright.

Are They Worth Considering?

As usual, this is where it gets difficult. The theory with these products (like many financial products) is fine but the problems start in practice when a lack of competition and clarity mean that charges are far higher than the value they actually deliver. For most, 'trading down' to a smaller property or to a cheaper area is likely to be more cost-effective way of unlocking capital, but it's inevitable that some people will not be able or want to follow this route. In such situations these plans are certainly an option to consider, but the products need to treated with more caution than most, especially while the gaps in regulation are still there. At least they do seem to be improving and the need for further improvement is recognised -- both of these are encouraging signs.

For the rest of us, it's yet another wake-up call to keep on top of our finances and make plans for our retirement as early as possible. The later you leave it the more likely it is that you will find yourself backed up in a corner where the choosing the least worst option is your only escape.

For those who want more information on this subject here is a selection of features (in increasing order of complexity): Age Concern | National Consumer Council | Actuaries Profession

Other related links: Homeowning Centre | Pension Centre