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Converting High Housing Prices Into Spendable Cash Is It A Money-Saver?

by Jim ONeil on April 19, 2013

in Mortgages

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Older homeowners are facing a miserable financial environment characterized by poor performance of pension plans, plummeting stock markets, and housing prices that are quite high given the state of the UK economy. The year 2011 saw a more than eleven percent increase in demand for equity release schemes, also called home income plans, from older homeowners.

More people are finding retirement to be far from blissful based on the status of their personal finances. But, is equity release smart or foolish from a financial perspective?

Equity Release Schemes And Their History

Many older people are short on cash but have respectable equity in their homes. According to a late 2011 estimate, British residents over age 50 have more than £750 million in equity in their homes. Equity is the extent to which the market value of the home exceeds any debt associated with it such as a mortgage. With an equity release scheme, a homeowner can claim some of this equity, convert it to cash, and use it for any purpose.

Most schemes require borrowing against the home and repaying only interest and capital upon relocation into institutional housing or death. In the early 1990s, many people found themselves on the wrong end of these schemes when share and home prices dropped and interest rates climbed.

Thousands of pensioners thought they were being smart by using money borrowed against their properties to invest in broker bonds. When these bonds did not perform as expected, the pensioners entered the world of negative equity, putting them into an even worse financial state than they had originally experienced.

Changes In Equity Release And The Potential Impact Of These Schemes

Modern equity release schemes have reduced risk, mainly due to a voluntary code of practice that applies to these safe home income plans, or SHIPs, drafted by major lenders. In addition, the Financial Services Authority (FSA) now regulates home income plans, providing consumers with additional protection. However, making a decision that affects the status of the home is serious, especially when the homeowner is retired. All the same, nearly one fifth of pensioners find themselves borrowing against their properties to repay their conventional mortgages.

Equity release schemes may seem like they provide relief but they simply exchange one type of debt for another. Since interest is not paid until the homeowner relocates or dies, rates are typically double that of conventional mortgages. These are not called lifetime mortgages for nothing. In just over ten years, the debt of a seven percent equity release scheme will double. Many people entering retirement will live for at least 20 more years, causing their beneficiaries to face a substantial equity release bill.

Why Pensioners Are Choosing Equity Release

Unfortunately, many pensioners are facing more pressing issues than worrying about inheritance for younger generations. They are trying to stay afloat and releasing equity in their homes can help them do this. Interest-only mortgages and pressure on pensioner income are combining to make equity release schemes more attractive. Where the money was once used to fund holidays during retirement, it is now being used to repay debts, cover home repairs, or address pension shortfalls.

Experts recommend that older homeowners review all the alternatives prior to using an equity release scheme. Those seeking money for home improvements might qualify for grants from a local agency. Pensioners should verify that they are claiming all benefits to which they are entitled. They should also be aware that accessing equity in the home could impact the benefits they are already receiving.

Proponents note that older homeowners are increasingly using equity release to raise capital or income. They note the availability of competitively priced lifetime mortgages that are safer than past schemes due to FSA regulation. Many plans offer a guarantee of no negative equity, where the lender will write off the excess if interest plus capital exceed proceeds from selling the home. A bright spot for beneficiaries is that during inheritance tax (IHT) liability calculations, debts are deducted from the gross estate of the homeowner. Therefore, up to 40 percent of the equity release price tag could be waived for an estate facing IHT.

Things To Be Aware Of When Considering An Equity Release Scheme

If equity release sounds like the answer to personal financial problems, consider several things before signing on the dotted line. Compared to other financing, these schemes typically have high interest rates, making them potentially expensive solutions. Look for a lender that follows the SHIP code of practice because this includes a guarantee that the borrower can remain in the home for his or her lifetime. The best schemes allow the borrower to move without triggering immediate debt repayment or penalties.

Equity release involves a substantial amount of money and problems can arise so retain an independent, unbiased solicitor to review the paperwork. If the contract is not clear, request a version that explains everything in plain English, not legal jargon that could be hiding unexpected terms and conditions. Take time to review all the different schemes because letting a salesperson rush the process may result in a bad borrowing decision.

Never select an equity release scheme that allows debts to exceed the value of the home securing them. Based on the average life expectancy of a typical pensioner, compounding interest can dramatically increase this debt. While thinking about the future, realize that running up debts against the home leaves less money for beneficiaries. Pensioners should consider discussing their potential decision with anyone who will be affected in the future. Revealing the benefit of potentially avoiding some IHT liability may make this conversation more pleasant.

Whether an equity release scheme is financially wise is based on the personal situation of the homeowner. When in doubt, homeowners should consult with a financial adviser but they should look for an independent party who does not rely on commissions from an insurance company. An equity release scheme is one way to unlock equity in the home but it should not come with any future financial surprises.

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