The right time to release equity?

Is now the time to take advantage of equity release? Interest rates for such schemes have remained relatively unaffected in a credit squeeze that has racked up the cost of traditional home loans.

Experts are arguing that equity release now provides an attractive option for asset rich, income poor third agers looking to release capital to fund desired lifestyles in retirement. But housing values and age longevity could conspire to produce, ultimately, a very bad deal with nothing left to pass on to dependants.

In essence, the more your house is worth, the more capital you can release, subject to any age restrictions imposed by the scheme provider. However, the longer you live the bigger your estate's interest bill will be from an equity release scheme.

The amount that can be borrowed also increases with age.

A 65 year-old could hope to obtain between 20% to 33% of their property's value; someone at 70 years is looking at a sum of between 25% and 40% of value. Amounts vary according to the scheme provider; Norwich Union, for example, has recently increased its loan-to-values, giving a 60 year-old up to 21% (17% previously).

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The cost is competitive

As we are all acutely aware, house prices are falling. They have dropped 7% since the start of the year, according to Halifax, and many forecasters now believe this fall could turn into a recession-led plummet of as much as a 20% decrease over the next year or so.

Do you act now?

A 33% equity release yields £100,000 on a £300,000 property but only £80,000 if the value has dropped to £240,000. As long as house prices keep rising, which hitherto has been the long term trend (with the occasional downward blip) then equity release debt remains a small part of a property's value. In a prolonged market downturn the loan will account for a larger proportion of that value. The relatively low interest payable on the debt currently favours action.

According to analyst Defaqto, an equity release mortgage now carries an average interest rate of only 0.53% more than a 10 year fixed rate traditional home loan; a year ago this discrepancy was higher, at 0.91%. The trade body SHIP (Safe Home Income Plans) says the average equity mortgage rate is now 6.21%, lower than the standard variable rate of most mortgage providers.

Historically the rate has always been higher, to reflect the 'no negative equity guarantee' offered by SHIP members; this promises that if interest payments mount up faster than the property increases in value, the homeowner or their estate will never have to pay the difference between the debt and the house on which it is secured.

Defaqto consultant David Black says: "Bearing in mind that the lifetime mortgage providers are shouldering the additional cost of providing the no negative equity guarantee, get no income stream during the scheme and also have no certainty as to how long plans will run, these figures highlight the extremely competitive offerings available in the equity release market."

Be prepared for heavy debt

Competitive maybe, but the outstanding debt can reach alarming levels. With the most common form of equity release, the lifetime mortgage, the interest payable on the loan is rolled up rather than paid off each month.

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Nothing gets paid off until you die or move house.

It's been calculated that a £40,000 equity release mortgage runs up a total bill of more than £185,000 over 25 years, assuming an interest rate of 6.2% (and admin costs of £1,200). Add another 10 years to the longevity of this loan and the total cost becomes in excess of £338,000.

Essentially the effect of rolling up interest doubles the debt every 12 years. SHIP figures show that more than half of all schemes are of a flexible, drawdown variety, which offers a way of reducing total interest repayments.

03 July 2008 © Moneyextra.com

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