Could coronavirus drive equity release?
Pippa Stephens looks at the implications of equity release after coronavirus for the insurance industry and consumers.
When I was teenager my father offered to buy me a Volkswagen Golf GTI if I agreed not to get married when I got older. He figured out it would be cheaper. I was sorely tempted. I liked fast cars, and I’d be cooler than my friends.
I think it was just tall talk, though. When I got married several years later, my parents helped a lot, as they did when I bought my first flat.
Lots of people across the UK are similarly lucky enough to be supported financially by their parents, and there are some eye-watering figures lying behind this.
Legal & General [L&G] estimated that over the course of last year, parents collectively lent their children £6.3bn towards buying homes, meaning if parents were a financial institution, they would be the eleventh largest mortgage lender in the UK.
With young people’s finances tending to be hardest hit by the coronavirus pandemic, it’s likely that many may be even more reliant on their parents for support, whether in the housing market or elsewhere.
It’s not clear to what extent parents are able to help their children, though, or even to support themselves. The furlough scheme will be scaled back from August, leaving the fate of its nine million participants, and their families, in the balance.
In order to weather the storm, with more dark clouds gathering on the horizon, many of the 12.5 million people across the UK who have suffered a loss of income due to the pandemic are looking around for options to bolster their finances.
Equity release is increasingly popular
Equity release mortgages, where capital is unlocked from a person’s property, have emerged as a popular way to do this, according to the Equity Release Supermarket [ERS] an equity release advice firm.
Inquiries to the ERS increased by 29 per cent in May this year compared to a year earlier, it said.
And the number of people who cited gifting to children as the reason for taking up the plans increased by 7.5 per cent in May compared to the previous four months of the year, it added.
The company’s CEO Mark Gregory said the pandemic meant people were “living differently, interacting differently, purchasing differently, and thinking differently”.
Helping out children is one way income from equity release plans can be used.
There are several others, the Financial Conduct Authority [FCA] recently noted.
It conducted research into the borrowing opportunities available to consumers aged 55 and over, after seeing “significant growth in the lifetime mortgage market in recent years”.
A lifetime mortgage is a type of equity release that allows some of the capital held in a person’s property to be tapped through a loan secured against their home, repayable when that person dies or goes into long-term care.
The upsides
The FCA noted “some” good outcomes when customers were sold an equity release plan well, allowing them the stability of a long-term fixed interest rate.
It said equity release plans had allowed consumers to:
- Repay their existing mortgage;
- Consolidate burdensome debts;
- Reduce working hours or fund earlier retirement.
But the FCA found some of the advice around equity release plans to be wanting.
“When consumers are given unsuitable advice, they can suffer major harm which affects them for the rest of their lives,” the report said.
It warned that ending the equity release contracts or repaying the amount owed early could be unaffordable and that short-term benefits such as consolidating debts and freeing up cash were “wiped out” by the long-term cost of equity release.
The downsides
The big factor in how much equity release plans cost in the long run is interest which tends to mount up rather than being paid monthly, and compounds over many years, meaning the debt can wind up being several times the amount borrowed.
Such accrual can be “particularly damaging where consumers actually have surplus income that they could have used to repay the debts, rather than consolidating them”, the FCA said.
Other poor outcomes for consumers included younger borrowers not being told of the other options available which may turn out to be preferable given the challenge of predicting finances over more than 30 years.
Those wanting to pay off the mortgage early because their circumstances had changed were hit by charges of tens of thousands of pounds only a few years after taking out their loan, said the FCA.
It issued warnings about:
- Insufficient personalisation of advice;
- Insufficient challenging of customers’ assumptions, and
- A lack of evidence to support the suitability of advice.
The financial implications of lockdown easing
Consumers looking at equity release as a short-term financial fix during the pandemic may be more vulnerable, said Claire Singleton, the CEO of L&G Home Finance, meaning “as an industry, we need to have our eyes open”.
Ms Singleton said she had also noticed equity release recently becoming increasingly popular, as retirement durations got longer and people aspired to stay in their homes.
She said: “It’s too early to gauge the full impact of Covid-19 on demand, but we anticipate homeowners may increasingly look to supplement their income, or support family members hit by the crisis.”
With lockdown easing, she said, people were looking to book holidays, plan home improvements and weddings, which would all drive demand for equity release.
Ms Singleton said the market had “transformed” in recent years, with greater flexibility, choice and competitive rates, and product innovation.
But that doesn’t mean equity release is the right choice for everyone, she said.
‘Cheaper ways’ to borrow money
She added: “It’s important we promote the fact that it is not an immediate needs product, and the advice process needs to reflect this.
“Particularly in light of COVID-19, potentially vulnerable customers need to be made aware that monthly interest can compound over time and that there are, perhaps, cheaper ways for them to borrow money depending on their circumstances.”
The way the pandemic plays out in the property market will also impact the uptake of equity release plans, according to Sarah Coles, personal finance analyst at Hargreaves Lansdown.
She said older people who had always planned to take equity out of their home may have had their plans to downsize disrupted by the pandemic. “Some properties are still selling with manageable discounts, but if you can’t get what you hoped for from selling up, you might start to consider alternative ways of releasing equity,” she said.
People who are in drawdown with no other investments to fall back on when investment values fall and dividends drop are currently advised to take less from their pension pot, to preserve more of the capital, said Ms Coles.
“If you don’t have anywhere else to turn, your home may become a consideration,” she added.
Ms Coles said it was “essential” people had a “full understanding” of the costs of equity release before going “anywhere near it”.
People should be aware that freeing up a lump sum could impact eligibility for the receipt of any government benefits, she said, and their ability to downsize in future.
The FCA’s review revealed some “worrying failures” in some of the advice given to people considering releasing equity, said Ms Coles.
“This could have a profound impact on their finances further down the track,” she said.
Implications for insurers
It’s not just consumers who are having to weigh up the risks as the uptake of equity release plans increases.
Insurance companies are having to take stock too. House prices in the UK have been rising for decades. But the coronavirus pandemic will bring volatility to the house price market. It already has.
Recent figures from Nationwide showed the average price of a house fell by 1.4 per cent in June and 1.7 per cent in May, the latter being the steepest fall since February 2009, during the financial crisis.
A continuing fall in house prices will adversely affect insurers’ profit and loss [P&L], according to Zsuzsanna Schiff, auditing and reporting manager at ICAEW’s Financial Services Faculty.
Equity release mortgages [ERMs] are offered to consumers with a no negative equity guarantee [NNEG].
This means people or their estate will never owe more than the property is worth when it is sold. If it’s sold for a lower price than was estimated at the beginning of the contract, the remainder of the loan will be written off. If the property is sold for more than the mortgage balance, the excess is paid to the borrower or their estate.
It’s these outstanding NNEGs that would hit insurers if house prices fall, said Ms Schiff.
She said bad planning for housing market volatility would hit insurers’ balance sheets and P&L, which would be reflected in their share prices, too.
Ms Schiff said ERMs would be likely to be controversial. They “could be an excellent product for the borrower” especially with an NNEG, but the risk for insurers lay with the valuation of the guarantee, she said.
House prices might fall, or the borrower might live for a long time, racking up an outstanding debt larger than the value of the property.
She added: “Whatever you do, people who take out these loans will not understand how expensive they are. Even if they get independent financial advice they still get caught out.
“In my opinion this will stay like this until you put numbers and a sample calculation in front of them which will show clearly just how pricey this option of financing yourself is. Compound interest is a wonder.”
Financial losses that could reach tens of thousands per consumer; and many times, that for insurers. The possible fallout from hastily sold equity release plans, amid market volatility, is sobering.
As people in the UK continue to be buffeted by the economic turbulence from the pandemic, and normal life begins again, to the extent that it can, the way the financial services industry responds to the FCA’s guidance will now be crucial.
About the author
Pippa Stephens is a freelance journalist in Berlin with over a decade of experience at FT business magazine Pensions Week, BBC News, BBC Business and the World Service.