UK: Equity Release. Another Problem Product?

Last Updated: 18 July 2018
Article by Matthew Goodwin

Equity Release Schemes on the rise

The number of people entering into equity release schemes has been on the rise in recent years as a result of their apparent ability to help with a multitude of financial issues. On the face of it, the schemes, which enable home owners to release wealth that is otherwise tied up in property, appear to offer a number of opportunities, including helping grandchildren onto the property ladder, enabling pensioners to do more in their retirement or clearing an existing mortgage. Equity release schemes are also being used to repay the wave of maturing endowment mortgage policies, entered into during the 1990's and early 2000's, which have under-performed, leaving home owners with an unplanned lump sum debt to meet. But are equity release schemes really as good as they sound, or is this another problem product, of which we will only see the downfall in years to come?

What is an Equity Release Scheme?

There are a number of different types of scheme, the main two being lifetime mortgages and home reversion plans.

Lifetime mortgages are the most popular, enabling home owners to remain in their property and take a loan against its value in exchange for a lump sum, regular income, or combination of both. The loan is not repayable until the home owner dies or moves into long term care.

Home reversion plans are where a percentage of the property is sold without having to move out of the property, in exchange for a lump sum or regular income. When the property is sold, the estate will only receive the percentage of the property that was not sold.

The Health Warning

The common element of these schemes is that they reduce the ultimate value of an individual's estate after their death or on moving out of the property.

With regard to the interest payable on the loans, some schemes enable home owners to pay some of the interest as they go along, or only pay interest on the amounts they draw down, however, where a lump sum is received with interest deferred, home owners need to be careful that the interest alone does not build up over time, drastically increasing the sum owed.

Some interest provisions work on a cumulative basis, meaning that homeowners are paying interest on the interest. Home owners that then remain in the property for a longer period of time can end up paying interest which is itself more than the original loan. When entering into an equity release scheme, home owners therefore need to plan for the possibility that they continue to live in the property for longer than perhaps first anticipated.

Individuals who are keen to leave something behind for their family need to be mindful of the impact the scheme will have on their estate. It is important that they receive independent financial advice and that all the options are explored with them.

Complaints about the advice received

The industry has seen an influx in complaints regarding equity release schemes as home owners pass away and the effect of the scheme bites. Many of the complaints raised by family members or beneficiaries of an estate are triggered because they had no prior knowledge that the scheme had been entered into – only discovering it when the estate which they were set to inherit has been, sometimes dramatically, reduced in value.

A beneficiary's lack of knowledge of the scheme can, in itself, become a legal issue if the adviser takes the stance that their duty of care in giving the advice only extends to the individual with whom they contracted. Where that individual has then passed away, it can become a legal debate as to whether that adviser also owed a duty of care to the beneficiaries of their client's estate. Whilst there is case law to suggest that the duty of care does extend to beneficiaries in respect of advice given by solicitors (as in the case of White v Jones [1995] 2 AC 465), the picture is less clear when it comes to the advice of financial advisers and accountants.

A Practical Example

  • A home owner (Mrs A) wished to carry out refurbishment works to her house and take a short holiday.
  • She did not have sufficient savings to fund these plans but had available equity in her home which was mortgage free and held on a leasehold basis.
  • Mrs A consulted a firm who recommended entering into a home reversion plan. No other funding options were discussed.
  • The plan provided the firm with an 80% interest in the value of Mrs A's house and required Mrs A to purchase the freehold of the property at an additional cost.
  • Mrs A retained a 20% interest in her property and the firm loaned her monies to pay for the refurbishments and her holiday.
  • The loan attracted a high rate of interest.
  • Mrs A relied entirely on the advice received from the firm and was not advised to take independent legal advice on the plan presented to her.
  • Mrs A lived in the property for a further 15 years.

When Mrs A died, the executor of her estate discovered for the first time that Mrs A had entered into a home reversion plan which had significantly diminished the value of her estate.

In this situation, it is likely that the advisers would be found to have acted negligently because:

  • They did not consider with Mrs B whether there were any other options for funding the house refurbishment and holiday;
  • The freehold was of little financial benefit to Mrs A and therefore not in her best interests; and
  • Mrs A was not advised to take independent advice in a transaction in which the firm stood to receive a financial benefit.

The information home owners should be given

Advisers should be addressing eligibility, the different types of equity release schemes available, the impact the schemes will have on the individual's estate following their death and whether there is an alternative method of achieving the individual's goals which may work out more cost effective for the borrower.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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