Page last updated at 23:33 GMT, Thursday, 4 October 2007 00:33 UK

The ins and outs of equity release

Money Talk
By David Elms
Chief Executive of Unbiased.co.uk

David Elms
David Elms
Millions of "cash-poor, property-rich" pensioners are surviving on meagre retirement incomes, but living in homes which have soared in value since the property boom.

A growing number are choosing to tap into the value locked up in their home to make the most of their retirement years through "equity release" schemes, which often seem an ideal solution.

These allow them to borrow money against the value of their home - either to get a lump sum or a regular income.

These are often marketed by their providers as a financial lifeline in old age.

But many have been unregulated, offering no compensation to buyers in the case of any mis-selling by financial advisers or providers.

Legislation that came into force this year will, critics hope, make this route safer.

However, they are a complex and expensive product, so it is vital to make the right choice.

Lifetime mortgages or home reversion?

There are two types of schemes available, and which one is suitable will depend on your circumstances.

The equity release sector... continues to hold pitfalls for consumers

With a lifetime mortgage, the more popular of the two plans, homeowners take out a secured loan on their property - usually of no more than 40% of its value.

The interest charged is then rolled up and repaid with the capital when the homeowner dies, or is taken into care, and the house is sold.

These mortgages account for 95% of the market, and have been regulated by the Financial Services Authority (FSA) since October 2004.

The second type, home reversion plans, do not work like loans but are, technically, sale and lease agreements.

Part or all of your property is sold to a provider for a cash lump sum - usually at a massive discount - although you keep the right to live there.

At death, its sale reimburses the lender and leaves the rest of the cash for any heirs.

Regulation

Home reversion schemes had not previously been under the FSA's auspices. But from 6 April this year they have been: a change that is expected to make a big difference.

The move put created a level playing field for product providers and made matters less confusing for customers, which should build confidence in the market.

Previously, home reversion schemes had been excluded from regulation because they were classed as property sales rather than loans.

But the plans have triggered concerns about potential mis-selling, for example by unscrupulous salesmen who offer them instead of lifetime mortgages to avoid the extra burden of regulation.

Also, given that the customers tend to be elderly and usually in financial need, they may have been particularly vulnerable to bad advice.

The regulation of reversion schemes will give borrowers greater recourse to compensation.

They will be able to turn to the Financial Ombudsman Service if they feel they have been mis-sold a product, and claim up to 100,000.

Still, for all the layers of protection, the equity release sector - worth well over 1 billion a year, according to the Council of Mortgage Lenders (CML) - continues to hold pitfalls for consumers.

Pitfalls of equity release

Take lifetime mortgages, where the rolled-up interest charges can amount to a hefty sum that runs the risk of leaving heirs with little from an estate.

Equity release is easy to get into but hard to get out of

For example, if a 60-year-old borrowed a 40,000 lump sum with a lifetime mortgage at a rate of 6.5%, the debt would more than triple to 140,945 by the time they reached 80.

Relying on rising house prices to ease this burden is a gamble.

Reversion schemes have also been criticised as poor value for money.

Homeowners are usually given a cash sum worth just 30-60% of the portion of the home they're selling.

As these plans can be difficult to understand, it is important homeowners know what they are agreeing to.

Once they sign, they are locked in.

Where to get guidance

It is essential to take expert guidance before going down the equity release route.

Safe Home Income Plans (SHIP), an equity release trade body, has worked hard to achieve respectability for the sector since it was set up in the 1990s.

It has a voluntary code of practice, but providers can choose whether to sign up or not. Many have not, so check this out.

SHIP members offer guarantees, such as right of tenure for life, a "no-negative equity" guarantee, the right to move and independent legal advice.

It will continue to guide people to quality products.

If you are thinking of equity release, research all other options first, such as downsizing or switching any spare cash savings to income-producing funds.

Sit down as a family and talk about not just the issues today but in five or 10 years time, when you might need to pay for care.

Equity release is easy to get into but hard to get out of.

The opinions expressed are those of the author and are not held by the BBC unless specifically stated. The material is for general information only and does not constitute investment, tax, legal or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Always obtain independent, professional advice for your own particular situation.


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