Loans Articles

There is a growing problem in the UK today which is facing many individuals who are approaching retirement age, that is having sufficient income to maintain their standard of living through their retirement years. There are several reasons why this could be the case:

People are generally living longer these days, due to advances in medical science and more healthy lifestyles. This, on the face of it, is surely a good thing. However, longevity can bring financial problems. Money invested in savings and pension schemes has to last for a longer period, meaning that income has to be spread more thinly. This also creates a problem for the Government in providing state benefits. As people are living longer, we are rapidly approaching a situation where there are more individuals drawing money from the state than there are paying into it.

The next problem is that of pensions. With recent changes in pension legislation and many companies withdrawing from offering schemes, or reducing the benefits available through them, coupled with poor investment returns over recent years, many individuals are receiving far less from their pension schemes than they had anticipated. These factors, coupled with bad publicity for pensions, such as the pensions mis-selling of the late eighties and early nineties and the “Mirror group” pension scandal, have disillusioned many individuals into not topping up existing pensions, or even not making any pension provision at all. This can only compound the problem in the future.

Many individuals own their own homes outright by the time they reach retirement, usually having repaid any mortgages or loans secured on it long ago. With the recent growth in house prices, this has made many people very wealthy indeed, with an asset often worth hundreds of thousands of pounds. Yet, for the reasons discussed above, they could well be short of retirement income. This “asset rich, cash poor” situation is becoming quite common and for those people who don’t want to sell their home or downsize to a smaller property, releasing the equity in their home through a lifetime mortgage, could be an ideal solution to the problem. 

“Lifetime Mortgage” is a generic term which is used to describe a whole range of products which allow homeowners to release equity from their properties, either through some form of secured loan, or through selling part of the home (reversion scheme). These products are designed in such a way that they are open-ended and no capital repayments are made to the lender during the term of the loan. The outstanding balance of the loan is usually repaid from the estate of the borrower upon death, or in the case of joint borrowers, on second death. This has the effect of providing the necessary funding for retirement, often without the burden of monthly loan repayments, thus offering peace of mind to the recipient.

Lifetime mortgages are considered to be a fairly new concept. The first plan, however, was introduced in the 1960’s. They generally fall into two broad categories: firstly, schemes which allow clients to borrow against the equity in their home, with the debt being repaid on death and secondly, schemes which allow a client to sell a proportion of their home to a finance provider whilst continuing to live in the property rent free until death. During the late eighties and early nineties, several schemes were introduced which were linked to investment bonds and interest roll-up plans, many of these causing more problems than solutions for the individual taking them out. These products created a bad reputation for lifetime mortgages and many individuals were put off following this course of action.

A conscious effort was made in the early nineties to try to restore confidence in the lifetime mortgage market. This included legislation being introduced to prohibit certain types of plan, a range of new products being introduced which offered better choice and protection for potential borrowers and a number of the larger financial institutions entering into the market. Probably the main thing to restore confidence in loans of this type was the introduction of the “Safe Home Income Plans” (SHIP) organisation in 1991.

The safe home income plans organisation was created by a group of lifetime mortgage providers to introduce a code of practice for those providing such products, which included more clarity and certain guarantees and protection for those purchasing them. Many providers are now members of SHIP and s such, must subscribe to the following code of conduct:

1. The members of SHIP agree to provide fair, simple and complete presentation of their plans. The benefits, obligations, variables and limitations must be clearly set out in their literature, including all costs which the applicant has to bear in setting up the scheme, the position on moving, the tax situation and the effect of changes in house prices.

2. The client’s legal work will always be performed by a solicitor of their choice. In all cases, prior to completion of the plan the solicitor will be provided with full details of the benefits the client will receive. The solicitor will be required to sign a certificate to the effect that the scheme has been explained to the client.

3. The SHIP certificate will clearly state the main cost to the householders assets and estate e.g. how the loan amount will change or whether all or part of the property is being sold.

4. All SHIP plans carry a “no negative equity” guarantee i.e. you will never owe more than the value of your home.

All of the major providers of lifetime mortgage products now subscribe to the SHIP code of conduct and anyone who is considering taking out such a plan should ensure that they use a SHIP provider because of the clarity and protection this provides. The SHIP logo will be clearly displayed on any literature provided by a lender who subscribes to the code.

There is a wide range of lifetime mortgage products available on the market today and we will look at these shortly. Although there are many different individual plans, there are several features which are common to most lifetime mortgages: most are only available above a certain age. This is usually 60, although some lenders will consider lower ages. At these lower ages to total loan to value ratio is usually quite low (commonly 20-25%). This amount increases as the age increases, due to reduced life expectancy. These plans will also take a first legal charge over the property in much the same way as a conventional mortgage would. They are all designed to release capital, whether this is in the form of a lump sum or regular income and most are open-ended. This means that no repayment of capital is due on the plan until either the borrower dies, the property is sold, or the borrower goes into long term care or sheltered accommodation. Most are set up as interest only loans, whether or not any monthly interest payments are made and most schemes are now regulated by the Financial Services Authority (FSA) as regulated mortgage contracts, with more regulation to be introduced in the near future to cover home reversion schemes.

The main types of lifetime mortgage plans are as follows:

Income plans: These are products which are designed to release cash which is then invested to provide a regular income for the borrower. The most common type of investment would be an annuity, which can provide an income for life, with or without a return of capital balance on death.

Cash plans: These products release equity in the same way as above. However, the lump sum generated is given directly to the borrower to invest in any way they see fit. This type of scheme could be used to repay outstanding debts, for example, or to fund home improvements. The use of the funds released is at the discretion of the borrower.

Open ended interest-only mortgages: with this type of scheme a regular monthly payment is made by the borrower to the lender, which is equivalent to the amount of interest charged on the loan for the month. Although there is the requirement to make regular payments on these products, there are a couple of advantages over other schemes. Firstly, as the interest is being paid off each month, the balance of the loan does not increase over the years. Secondly, it is usually possible to borrow a higher loan to value ratio (particularly at younger ages) than other types of scheme, due to the fact that the loan balance will not increase.

Interest roll-up schemes: In this case no monthly payment is made to the lender. Interest is rolled-up on the loan so that the outstanding balance increases as time passes. This can have a significant effect on the total mortgage balance over a number of years, particularly when the plan is taken out at a relatively young age. For example, if interest is rolled up on a scheme for a period of ten years, the outstanding balance could be more than double the original amount borrowed. For this reason loan to value ratios are usually lower at younger ages (e.g. 20-25% at age 60), increasing as the age of the borrower increases, due to shorter life expectancy and therefore less time for the interest to be rolled up.

Drawdown mortgages: These work in much the same way as the roll-up mortgage schemes. The main difference with this type of plan is that the total lump sum available is released in stages, rather than as a single lump sum. This could be in the form of a monthly payment or other periodic interval. The benefit to this type of plan is that interest is only charged once the funds have been released and therefore interest does not roll-up on the scheme as quickly as one where the lump sum has been released as a single payment, particularly in the early years of he plan. 

Shared appreciation mortgages: In this case no monthly payments are made to the lender and no interest is charged on the loan balance. Instead of charging interest, the lender would take a percentage of the growth in value of the property (e.g. 30%) between the inception date of the loan and the point where the loan is repaid (i.e. on death of the borrower). For example, if the value of the house increased by £100,000 between the start date of the loan and the death of the borrower, using a shared appreciation rate of 30%, the lender would receive £30,000 plus the original sum advanced.

Reversion schemes: These schemes differ from those listed above due to the fact that they are not mortgages. With this type of scheme, the funds are raised by the homeowner selling part, or all, of their property to the provider, who then releases a percentage of the value purchased to the homeowner. A legal contract is drawn up allowing the homeowner to remain in the property, rent free, either until the property is sold, the owner goes into long term care or sheltered accommodation, or the owner dies. At this point the property is sold and the provider receives the equity share originally sold to them. How much money is actually made by the provider on this type of scheme is dependant on the increase in property values rather than on interest rates.

There are other factors which a potential borrower should be aware of prior to entering into a lifetime mortgage. Taking out such a product can significantly reduce the value of an individual’s estate on death, particularly where interest has been rolled-up on a scheme. If a potential borrower wishes to leave a legacy to family or loved ones, they should consider their options carefully. It is a good idea to consult any potential beneficiaries, making them aware of the implications, before entering into such a plan. Any extra income or lump sum derived from a lifetime mortgage may also have a detrimental effect on means tested state benefits (such as income support) and also Government housing grants, which may be available to an individual. Extra income could also reduce an individual’s age allowance for income tax, meaning that a borrower could end up paying more tax as a result of entering into a lifetime mortgage.

This article has been intended as a brief introduction and overview to lifetime mortgages. As we have seen, there are many different types of scheme and products, each of which provide different benefits. Before entering into such a scheme, you should fully understand the different types of plan and also what, exactly, you want from it. This can be a very complicated area of financial planning and extremely expensive if you get it wrong and it is therefore vitally important that you seek independent financial advice from a suitably qualified adviser, who will be able to guide you and your family through the various benefits and pitfalls of lifetime mortgages.