Several surveys have recently been published showing the majority of retirees will have to draw on some of their housing wealth to fund their retirement. For many downsizing is not something they look forward to. So releasing equity while remaining in their home appears to be what the majority are looking to do.
With new providers coming into the market all looks good news for the equity release sector. But is it?
The aforementioned surveys have received good coverage in the popular press – more good news. Yet here comes my worry, the phrase ‘expensive equity release’ is repeatedly used by journalists in their articles. The more this phrase is repeated the more it will stick. ‘Expensive equity release’ could become as tarnished as ‘rip-off annuities’. If asked many retirees will respond that they want a guaranteed income for life – they are describing an annuity but many do not want to buy a ‘rip-off annuity’.
An annuity is a reverse mortgage. Instead of the lender giving you a lump sum that you repay over time in instalments of capital and interest, the annuitant gives their money to the annuity provider who returns it to them in instalments of capital and interest. The term of the annuity is determined by how long the annuitant lives.
If you’re that way inclined, you could play with Excel and find the different internal interest rates generated for different life expectancies of an annuitant. A short period of survival will produce a negative internal interest rate. Average life expectancy should produce a low positive rate but the longer the annuitant lives the greater this rate becomes.
We know that a 65 year old will live around 20 years more on average. However what if they live 30, 35 or even 40 years? That internal rate of interest will show the annuity purchase to be good value. That is not all.
The chances of living until 105 are about 1 in a 100. What are the chances of your house burning down? Probably a lot less but most of us buy house insurance for the value of peace of mind. Annuities give that peace of mind so there is the added value of receiving a guaranteed income for life. That is what consumers say they want and will therefore value.
The same principles apply to equity release. Before saying the product is expensive look at the value it delivers. Equity release interest rates have fallen as low as 4.7% recently. Ignoring fees, typical fixed mortgage rates are currently around 2% for two years; 2.3% for five years; and 2.75% for 10 years. At first glance the differential may appear expensive however let us look more closely at what is on offer.
The average equity release contract exists for around 15 years. What would be the interest rate on a 15-year fixed-rate mortgage? With a fixed rate mortgage, the borrower takes a market risk: what rates will be available when the rate guarantee expires? What value can be placed on this risk not existing with equity release? As with an annuity there is an element of insurance in the equity release contract. The rate is generally guaranteed for life. What if the equity release contract remains in force for 25, 30 or even 35 years? How valuable is that fixed rate of 4.7% for these periods? Is this the equivalent of the peace of mind and value that house insurance provides?
This view of course also overlooks the no negative equity guarantee available with the vast majority of equity release products. These have the effect of capping the interest rate if the equity release loan exceeds the value of the home.
Finally there is the value of giving the consumer what they want – which is to remain in their home. Different individuals will place different values on this depending how strong the desire to remain is.
So, when approached this way is equity release expensive? A car is a lot more expensive than a bicycle. Most consumers consider the added convenience they get with a car is good value for money. The same arguments should therefore arise with equity release when compared with the alternatives.
Bob Champion is chairman of the Later Life Academy (LLA)