Equity release is a very pricey subprime loan

By MoneyWeek editor-in-chief Merryn Somerset Webb Jan 27, 2012

Merryn Somerset-Webb

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The equity release industry is pleased with itself. According to Key Retirement Solutions, one of the market’s big players, it is “firmly established” back on a growth trend.

In 2011, 22,366 new plans were started and £959.6m in total was released from people’s homes. That’s big money. Fans of equity release (or lifetime mortgages) say this makes sense. The elderly often need money and rarely want to leave their homes. So if they can borrow against their house and leave the money to be repaid on their death, why not? But the truth is that equity release is an exceptionally expensive way for the retired to borrow money.

From a lender’s point of view, lending like this should be expensive. Why? Because it’s effectively subprime lending. The borrowers have no ability to repay the debt from income or from non-property assets, and you also have no idea when the debt will be serviced or repaid. So of course you charge high rates of interest. The problem is those who take out these loans often have no idea how pricey it is – simply because they don’t understand how fast compound interest mounts up.

Say you take out a £50,000 loan against your house when you are 70. You pay 6.5% interest (note you can get an ordinary ten-year repayment mortgage for just 3.9%). Then you live until you are 90. The debt, now consisting of the capital sum plus 20 years of interest on interest, will come to £176,182. That may not matter to anyone desperate to stay in their home and with no other funds or living relatives. But I think we can be sure it will matter to most other people.

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Most of us who are able to would surely be better to downsize to a cheaper house: that way you get the lump sum of cash but without the ongoing horror of a compounding debt. Those who take this route will also be giving themselves another bonus. As you downsize you will also go through all your things and sort out the useless from the useful. You’ll be selling or distributing bits of furniture that won’t fit into your new house. And as you go you’ll also be making a mental inventory of your possessions.

That makes it the ideal time to add some specifics to your will: you can use the move to decide who is getting what, to write it down, and if needs be explain your decisions to your heirs.

Do all this and not only will your move make your life better (you’ll have a pile of cash and you’ll be organised), but you’ll be giving a gift to your children. They won’t have to clear and sell their childhood home or deal with the risk of falling out over a painting they all love that isn’t mentioned in your will. I think they’ll thank you for it.

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Published in Mortgages | More articles by Merryn Somerset Webb

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  • 1. Steve Laird

    (27 January 2012, 09:26AM)  Complain about this comment

    Whilst downsizing is a better option for most, equity release is the only option for some parts of the country where the housing market is at a virtual standstill.

    Given the amount of QE that will have happened by the time we get out of this crisis, the resulting inflation will make a fixed interest rate of 6.5% look like a bargain.

  • 2. bravomar

    (27 January 2012, 10:01AM)  Complain about this comment

    Downsizing may well be a better option financially, as well as the lifestyle or esoteric benefits listed by Merryn, but not suitable for everyone. Most people do not live in 5 bedroom detached houses in the 'burbs worth £ 800 K + making downsizing a viable idea. Most of the people needing equity release are in extremely modest homes where a downsize move might release thruppence, as well as a move to a much less desirable area away from family/friends. Equity release may be expensive compared with the normal mortgage market, but it gives a much neeeded income boost at the expense of other generations' inheritances. This is the equity releaser's money not their relatives. As one who hopes to inherit - it's my pension plan - I have to acknowledge that the money is actually my parents and if they need income and this expensive route is the only way to provide it, then it is their right.

  • 3. Daytona

    (27 January 2012, 06:18PM)  Complain about this comment

    I have a 62yo friend who's recently done the (financially) sensible thing and traded down from a 3 bed semi to a 1 bed retirement flat releasing £100,000.

    She found the process of divesting herself of a lifetimes possessions a harrowing experience, causing a heart attack along the way.

    The equity release vs. trading down is more of an emotional argument than a financial one.

  • 4. Boris MacDonut

    (27 January 2012, 06:24PM)  Complain about this comment

    #3 Well said Daytona. The crucial bit of the credit crunch was the lack of understanding of human emotions. Accountants genuinely fail to comprehend the real world because they think like an abacus, when human nature is so much more complicated. As for Equity Release, it is a throwback to pre credit crunch rules/morals. An attempt to rip off the poor and make a fast buck ......spurn it as you would spurn a rabid a dog.

  • 5. Chris Downing

    (09 February 2012, 06:55AM)  Complain about this comment

    Ha. I can see talking about equity release upsets some people who have a distant relationship with reality. Equity Release is borrowing money against the asset value of your house - you can call it whatever you like to disguise that - it is borrowing with no way of paying this back. It is a stupid option. Downsizing is what people need to get to grips with. And as for the angst of moving - I can't imagine what it feels like to end up with a greater and greater debt that will eventually become bigger the value of the house. Get real about what needs to be done. Equity Release is just another version of the sleepwalking that passes for finacial planning in the property market.

  • 6. Jason Dean

    (28 February 2012, 11:40AM)  Complain about this comment

    Not sure the author knows too much about life at the tail end of the human life span.

    The example of a 70 year old getting a 10 year repayment mortgage at 3.9% - good one.

    The question this article and most fail to pick up is:

    Equity release is expensive compared to what?

    Compared to the 10 year 3.9% yes the interest rate is expensive. But you're comparing apples with a quince from the garden of eden. One is attainable, the other isn't.

    And how anybody can not know how fast the interest compounds, when the illustration at a fixed rate shows precisely this, with 25 year predictions, is beyond me. In fact, because of the fixed rate, the rate of compound is one of the financial service industry's only certainties. There is no ambiguity and no ignorance - it is there in black and white.

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