Lenders’ equity release calculations don’t add up

A quick scan through the available deals on a well-known website shows them to typically range within the 6-7 per cent band.

Compare this to the 10-year fixed rates (from 3.49 per cent) available in the conventional mortgage market and that seems to suggest quite a hefty margin.

So, is this simply the ‘risk premium’?

Well, looking at the terms of one of the most generous loan-to-value (LTV) lenders for a 70-year-old, the maximum LTV is quoted as 36 per cent.

I ran some projections to see when negative equity would kick in at an interest rate of 6.5 per cent.

There will be short-term volatility in property growth (even negative growth) but short term isn’t a problem for the lender

If property prices remain at their current levels, based on a rate of 6.5 per cent, an occupant needs to reach the age of 87 before the lender has exposure – above the average life expectancy for a 70-year-old UK male (albeit not by much). So far, so fair.

But if we build in a modest expected growth rate (EGR) for property values of 2.5 per cent per year, then the loan stays in the black until age 97. And at 4 per cent EGR it’s only the 114 year olds who pose a problem (assuming they aren’t in residential care by then).

There will be short-term volatility in property growth (even negative growth) but short term isn’t a problem for the lender because, in the early years, there is ample equity to cover anything but the most catastrophic decline in prices.

So, are lenders really envisaging long-term negative property values?

Of course, if it were profitable to run equity release at 5 per cent interest rates, some enterprising lender would surely do so – thereby scooping up the market. But, as we have already seen many times, markets aren’t always as efficient as we might want to believe.

It would be interesting (if I were a regulator) to closely scrutinise the profit margins that lenders post on their equity release books.

Ivor Harper is director at Park Financial