Mortgages  

Beware early repayment charges on equity release

Stuart Wilson

Stuart Wilson

In recent months, the coronavirus crisis has led the Bank of England to make some drastic changes to the UK’s monetary policy.

It has significantly reduced the base rate to counteract the impact of the UK’s lockdown on the economy and has also committed to a £200bn purchase of UK government and corporate bonds as part of its quantitative easing programme.

All this, along with the huge economic uncertainty facing us over the coming months, has meant a record drop in government bond yields, also known as gilt yields. This naturally has far-reaching consequences for many industries and the equity release market is no exception.

Let me explain. 

Equity release products are lifetime plans intended to be redeemed when the borrower goes into care or passes away.

Should the borrower wish to sell the property and/or repay the loan before this, they will need to pay an early repayment charge (ERC) – a similar concept to when you redeem your residential mortgage before the fixed term is up.

ERCs come in two flavours – gilt-linked and fixed. 

As a lender, more2llife currently only offers fixed ERCs as they are simpler to understand and people know exactly how much they owe at any point.

Gilt-linked ERC’s mirror the movements of the gilt market so if a customer takes out a plan when gilt rates are high and tries to sell when rates are low, they will find that they could have a higher redemption fee to pay than when they originally took out the loan.

Recently gilts have fallen so the ERCs that someone who chooses this feature today will pay are lower. 

That said, it is also important to remember that although gilt rates are currently at an all-time low, they may drop even further and become negative as we have seen in Europe.

This could mean a higher redemption fee in the future for customers who take out equity release plans this year.

And that is the challenge with these products, as even the smartest economist would be nervous about tying themselves into a deal whereby they had to pay a fee to redeem an unspecified amount of debt on an unspecified date in the future based on unknown gilt rates.

Fundamentally, advisers should be outlining the potential benefits and drawbacks of gilt-linked and fixed ERCs to customers to help them understand which plan will best meet their short and long-term circumstances.

Arguably the first question is – do you see yourself moving in the future?  If they answer in the affirmative then a feature such as downsizing protection can be chosen to manage this risk. 

While this is not the case with more2life, some lenders will increase the interest rate on the borrowing slightly but it provides clients with the peace of mind that if they do want to move then they have the option.