There has been much talk of interest-only mortgage time bombs over the years, but now experts are warning that they could be joined by equity release time bombs.
The UK financial regulator has launched a probe into the selling of equity release mortgages after claims of ‘rampant mis-selling’.
The announcement of the probe has been welcomed by leading charities and financial experts because they believe many elderly and vulnerable people are signing up for long term loans without being aware of the potential for expensive compound interest and hefty penalties for early redemption.
Experts also claim the interest payments on the loan could erode the total value of the property they are secured on, leaving retirees unable to downsize or to leave anything to their children.
The Adam Smith Institute (ASI) think tank claims there is ‘a scandal brewing’ because the Prudential Regulation Authority (PRA) has ‘known for years that companies’ valuation methods are inadequate and have only made half-hearted efforts to address the under-valuation problem’.
A report produced for ASI by Professor Kevin Dowd said: “We never seem to learn. Equitable Life hit the rocks two decades ago because it under-valued its long-term guarantees.
Now the equity release sector is in deep trouble for the same reason. In both cases, the firms involved got into difficulties because they were using voodoo valuation methods that had no scientific validation.”
Trebled in size
ASI says the equity release market has trebled in size between 2012 and 2017 and is forecast to rise a further 40% by the end of next year.
It is a way of allowing older homeowners to release some of the equity in their home to fund their lifestyle in retirement or to pay for sizeable projects they might have.
Effectively, it is an interest-only loan that the borrower does not need to make any repayments on with the interest being saved up until the client either leaves the home, dies or goes into long term care at which point both the capital and interest must be repaid.
Financial journalist Sara Benwell said: “If you take out an equity release loan at 55, you could easily be accruing interest for 30 years until it needs to be repaid. The average interest rate for these products is 4.9%, meaning the size of your loan would double every 14 and a half years.
Double in size four times
“For those who took out plans over 5-7 years ago, when rates were up to 8%, a 55-year-old who lives to age 90 would see the debt double in size four times.”
Former pensions minister Baroness Ros Altmann said: “The interest roll up can be really destructive of the capital value… The younger you are when you take out these loans, the more dangerous it can be.”
A good thing
Charities feel equity release can be a good thing, but needs to be carefully regulated.
Caroline Abrahams of Age UK, said: “The equity release market is growing fast and there are lots of adverts promoting it both online and off.
“It is tremendously important that older people are not rushed into making a purchase they may come to regret later on, and that they get authoritative and clear information and advice so they understand the consequences before they buy.”
Sue Anderson of the StepChange debt charity added: ‘It’s a market that needs good regulatory scrutiny to make sure that it doesn’t develop in the wrong way or financially disadvantage people which can cause them significant problems later in life.’
Good customer outcomes
A spokesman for the Equity Release Council said: “This is a prudent and highly regulated area of financial services to ensure market stability and good customer outcomes.
The PRA is currently consulting on equity release regulations and the council and its members will continue to engage constructively on this matter.
“While the detail of pricing decisions are commercially sensitive, common factors in offering a no negative equity guarantee include three fundamental lines of security: a prudent view of house price trends with allowances for future uncertainty; stress tests for very adverse scenarios; and significant extra risk capital to ensure that, in an extreme adverse event in the residential property market, providers remain able to meet future obligations to policyholders.”