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Equity release plans can be split in to two main categories. Those where you retain ownership of your home (Lifetime mortgages) or where the loan provider buys the property and you remain as a tenant for life (Home reversion plans).
Definition of a lifetime mortgage
a. Age restricted – only available to older customers – 55 or over.
b. No fixed term – mortgage is repaid under one of the following called an event subsequent:
1. Death of borrower/s.
2. Owner moves to another property or long term care and has no reasonable prospect of returning.
3. Acquire another property.
4. Repossession by lender due to breach of contract.
c. Customer occupies the property under following conditions :
1. No capital repayment or interest on capital repaid whilst living.
2. May select to pay interest but not full or part repayment of capital.
d. Maximum equity that can be released is usually 35% of value of property.
HOW DOES EACH PLAN WORK.
HOME INCOME PLANS
Equity is released in the form of a loan, which is used to purchase an annuity of a type called the Purchased Life Annuity. Part of the income generated from the annuity is used to pay interest on the mortgage and part is used for personal needs. The income generated can be fixed or index linked.
Modern home income plans are no longer tied to purchasing an annuity. However, home income plans have fallen out of favour with both providers and borrowers due to their inherent inflexibility.
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When can a customer borrow more money?
COMPARISON OF EQUITY RELEASE PLANS
TYPE
|
ADVANTAGES
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DISADVANTAGES |
| Home income plans – quite unpopular these days. |
Annuity in terest rates are fixed and would not be affected by future fall in rate.
Retain ownership of property.
Tax advantages – part of the income is tax free.
Those with impaired health can obtain higher interest rates.
Portable.
No income assessment needed.
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Inflexible i.e. once an annuity is taken it cannot be redeemed.
No part of the investment is returned to the customer or dependents – inflexible.
Cannot gain if future saving rates increase.
Mortgage interest may rise whilst annuity rate is fixed.
Interest higher than a traditional mortgage. |
Cash Plans with interest payments
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Reduces inheritance tax liability.
Retain ownership of property.
Gain any increases in future value of property.
Negative equity guarantee.
Portable.
|
Reduces value of the estate that can be passed on to dependents.
Interest higher than a traditional mortgage. |
Cash Plans with no interest payments
|
Reduces inheritance tax liability.
Retain ownership of property.
Gain any increases in future value of property.
Negative equity guarantee.
Portable.
No income assessment needed. |
Interest is capitalised – can double the loan every 10 years at 7% interest.
Reduces value of the estate that can be passed on to dependents greatly.
Lowers the equity available for future borrowing.
Interest higher than a traditional
mortgage. |
| Shared appreciation loans |
No interest to pay.
Advantage to the borrower when property prices are falling.
Reduces inheritance tax liability.
Retain ownership of property.
Repayment is not affected by prevailing interest rates.
Portable.
All up front costs can be added to the loan.
No income assessment needed.
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Loss of future appreciation of value.
Reduces value of the estate that can be passed on to dependents.
Conditional subsequent the property must be sold and the loan redeemed. |
| Home Reversion Plans |
Higher loans
No monthly payments.
No income assessment needed.
Reduces inheritance tax liability.
Advantage to the borrower when property prices are falling.
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Inflexible.
No longer gain from any future increases in value.
Seriously effect what can be forwarded to next of kin.
|
Traditional mortgage
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Lower rates compared to equity release schemes.
Gain 100% of future in crease in values.
Higher level of equity available.
Ability to raise money through other loans.
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Stricter lending criteria - with proof of income etc.
No safeguard regarding falling value.
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CASH PLANS
These are the mostcommon form of Lifetime mortages these days. The advantage is that funds are not linked to purchasing an annuity, therefore giving the borrower flexibility in how he uses the funds. The maximum loan is usually limited to 25% of the value.
The lender provides a mortgage on a first charge basis (therefore the property has to be mortgage free). The customer remains the owner of the property.
Cash plans may also be available in drawdown basis. That is the loan is taken in stages as and when the customer needs funds. Advantage is that the overall interest payments will be lower compared to immediate withdrawal of the whole fund.
CASH PLANS WITH INTEREST PAYMENTS
Here part of the funds are used to pay interest on the loan. The capital owed therefore remains constant throughout. The loan is discharged when an event subsequent occurs.
As there are interest payments involved the lender will assess your ability maintain payments and affordability.
CASH PLANS WITH NO INTEREST PAYMENTS.
The customer pays no interest on the money borrowed. Instead the interest is capitalised on to the loan. This leaves greater amount of the loan available for the customer’s own needs. However, capital owed or the debt will accelearate as the compounded ineterest is added to the loan thus reducing the estate that can be passed to dependents further.
At an interest rate of about 7.5% the capital owed will double every 10 years.
SHARED APPRECIATION MORTAGES
These were introduced in the 90s. The borrower pays no interest on the loan, instead the lender takes a share of the property through a first charge. Interest is recovered from the profit generated on lender’s share on sale of the property on a condition subsequent.
For example : The lender takes 30% share on a property valued at £80,000 to provide a loan of £20,000. If the property appreciates at 2% a year and the borrower dies in 10 years, the value of the property at redemption will be £97,520.
The lender’s return will be share of the profit of £5256 (30% of 17,520 ) + return of capital of £20,000 , totalling £25,256.
This type of lending has become less attractive to lenders as the lender has to manage the risk by buying a hedging instrument in the financial markets. Also in a market where the property prices are falling lender’s profits becomes unsustainable.
HOME REVERSION PLANS (HRP)
This is type of plan in strictly not a mortgage, however, since April 2007 they are still regulated by the Financial Services Authority.
The home owner sells part or whole of the property to the plan provider, but is allowed to remain as a tenant until death or vacation of the property due to a event conditional (also called a qualifying termination event). The plan provider purchases the property through legal conveyance (reason why they are not a mortgage) and becomes the legal owner of the property. A consequence is that unlike an equity release scheme, HRPs allow higher levels of funds to be released.
When a qualifying termination event occurs, the plan provider takes over the property and sell to obtain their profit. As the transaction is irrevocable the borrower will loose 100% any future increase in value of the property.
If only part of the property is sold to the lender, the current owner becomes part owner/ part tenant. A tenancy in common is set up at the land registry. In a qualifying termination event the owner’s share reverts to the estate.
TRADITIONAL MORTGAGE
You can always consider a traditional mortgage to raise capital on your home. However, since beginning of 2008 this route has become more restrictive. Due to the recent credit crunch and the fear it has generated within the lending community many have tighten the criteria required for traditional mortgages. Lending for the retired has become stricter with many lenders requiring evidence of income and affordability.
There are still few lenders active in this market; subject to clients having very good credit status. The obvious advantage of traditional mortgages are the low interest rates and the flexibility. The borrower can remain in their property, with no restrictions on sale, future capital raising or moving property. They will also retain 100% any increase in value in the future.
The mortgage can be taken on an interest only basis to be repaid on the death of the last remaining borrower, through the property’s sale by the beneficiaries.
Things to consider before taking up a contract.
The question you need to ask yourself is that are the benefits offered by the scheme out weighs the losses and limitations .
Affordability - can you afford the new loan and maintain payments in the long term. Identify what can change in your financial circumstances in the future. Take in to account your current fixed outgoings and income. Can there be unforeseen needs such as a medical need, moving abroad, new transport.
Debt consolidation - If the loan is used for debt consolidation, consider if it is appropriate for you to extend the term of the loan just to reduce the monthly payments. Also if unsecured loan is secured on the property is this the best option.
If you are having difficulties with maintaining existing loan payments, it may even be better to negotiate with the current loan provider to arrange a different payment option, rather than entering in to another loan agreement.
Inheritance – By borrowing on your property you will inevitably reduce the value of your estate and what is bequest to the family. Those who may have a potential inheritance tax liability, this may be an option to reduce the tax bill.
Health and life expectancy – if you are suffering from ill health this is an option to release tied up wealth in your property. However, you also do not want to
Taxation
Any money borrowed can affect your tax situation and assistance with some benefits.
Three main taxes affect individual :
• income tax – charged on earned income including saving, annuity and pension income.
• capital gains tax – charged on profit made between buying and selling an item (except your home).
• inheritance tax – tax on the estate on death.
Some income is exempt from income tax. This includes:
• certain National Savings and Investments (NS&I) products, e.g. National Savings Certificates, and Children's' Bonus Bonds;
• cash ISAs, PEPs and TESSAs from the past;
• qualifying life assurance policies;
• winnings from gambling.
Some income is paid gross but is taxable according to your personal tax status:
• interest on gilt-edged securities;
• income from certain NS&I products, e.g. Pensioner's Bonus Bonds;
• income from offshore funds.
Also some type of income is taxed at source, that is, tax is deducted (at 20%) before the money is paid. Higher rate tax payer’s have an additional liability, whilst non-taxpayers can reclaim using the form R85. Examples are bank and building society deposits.
Means tested state benefit.
Certain state benefit is dependent on your existing savings and income. The main benefits are jobseeker’s allowance, income support, council tax benefit, housing benefit.
Means testing takes in to account :
1. the level of savings and investments.
2. Regular income through work or pensions.
3. NI contribution record during your working life.
Here is a summary of benefits that are affected by means testing.
Jobseekers allowance (JSA)
Paid to those who are looking for work whilst unemployed. It is the main source of income for the unemployed replacing unemployment benefit.
The level of JSA is determined by your income, savings and NICs.
| Benefit |
Income |
Savings |
NICs |
Age |
1. Job seeker’s allowance
2. Income support
3. State pension credit
4. Council tax credit
5. Bereavement allowance
6. Widowed parent’s allowance
7. Funeral allowance
8. Incapacity benefit
9. Severe disablement allowance
10. Attendance allowance
11. Disability living allowance
12. Disabled person’s tax credit
13. Invalid care allowance
14. Nursing care contribution* |
x
x
x
x
x
x
x
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x
x
x
x
x
x
|
x
x
x
x
x
|
x
x
x
x
x
|
* Paid to the care home directly at £101 per week and offset the cost of care.
Income support
Benefit for those on low income. Savings and investments over £6000 lowers the payment, with over £16,000 eliminates entitlement.
State pension credit
Benefit paid to the elderly (age over 60) to ensure there is a minimum income to live on. Replaced minimum income guarantee in 2003.
The benefit is paid in two ways.
1. To guarantee a minimum income – topping up of existing income to reach £119.05 per week for a single pensioner or £181.70 for a couple (inc civil partnership).
2. A saving credit – For those over 65 (or at least one partner is) a reward for saving is given even if the income is over the minimum guarantee above.
Any income above the state basic income is credited with 60p per £1 of income up to state pension credit limit. Above this limit the credit is reduced by 40p per £1 of income. Savings are treated as £1 income per week for every £500 of savings above £6000 or for those in residential care above £10,000.
Council tax credit
As the tax is based on value of the property, those who are equity rich but income poor can be disproportionately affect. Those above 60 years and on low income is eligible for this credit, which is measns tested on basis of income and savings (no more than £16,000).
Bereavement benefits
Bereavement Allowance - payable for 52 weeks to the surviving partner following a bereavement – means tested subject to NICs.
Widowed Parent's Allowance - a regular payment to a widow or widower bringing up children, or to a widow expecting a deceased person's child - means tested subject to NICs.
Funeral Payment - a one-off payment made to defray some or all of the costs of a funeral - means tested subject to income and savings.
Sick and disabled
There is a variety of benefit available.
Incapacity benefit – means tested on NICs.
Severe disablement allowance – means tested on
Attendance allowance – paid for those who are mentally or physically ill and over age 65 and in need of personal care. Not related to income or savings.
Disability living allowance – paid for those who are mentally or physically ill and under age 65 and in need of personal care. Not related to income or savings.
Disabled person’s tax credit – means tested on NIC, income and savings.
Invalid care allowance - means tested on income.
Additional information on all the benefits can be obtained from following sources, the Department of Work and Pension website (www.dwp.gov.uk - can also give you the number for local social security office), local council and the citizen advice bereau.
Long term care
There is no state provided entitlement for long term care in the UK except in Scotland (age 65 or over). Although you may be eligible for financial support in full or in part depending on your financial situation.
Those who are assessed to be able to afford care is expected to fund the needs from their own resources.
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