Will Equity Release Complete the Journey to Redemption?
Consumer concerns about Equity Release
Most Advisors working in the Equity Release industry experience one of the most challenging aspects of their role as overcoming the misperceptions held by the public in relation to Equity Release.
Compound interest, High-Interest Rates and inflexible deals are the main areas that the public has heard about that are barriers to them exploring Equity Release as a viable option. Even when they do decide to find out more, many are naturally suspicious as they have heard `horror stories’ through friends, family and the media.
The Equity Release Council
The Equity Release Council have worked hard to improve the reputation of the industry, providing clients looking seeking accurate advice with confidence that if they choose an ERC member to advise them, they are highly professional and act with integrity and transparency in offering high-quality products and services to customers.
Despite these commendable improvements, there are several remaining factors that continue to impact current products: Early Repayment Charges, Regular Client Reviews and the creation of Equity Release `prisoners’ through legacy products, all of which require further scrutiny:
Early Repayment Charges
The perceived unfairness of Early Repayment Charges has been a constant source of dispute within the industry. The rate at which they are set is a balancing act between ensuring profitability for the funder and the fairness of the charges to customers.
Undeniably, the cost of establishing and operating an Equity Release business needs to be balanced with all businesses involved in the process of maintaining profitability. Consumers understand this, as do brokers.
What is not clear or understandable is the duration of the ERCs and the percentage of ERC that can be taken in relation to the loan. As a recent example that Ocean Mortgage has experienced, a client took out £25,000 using a Lifetime Mortgage 18 years ago. The loan increased to £85,000 over a period of 13 years, yet the ERC was over £20,000. This ERC feels disproportionate and unfair.
If the product had a Fixed Rate ERC, it is likely that the equivalent ERC would have been zero after this time.
Should we see an end to Variable rate ERCs?
I have previously asserted, somewhat controversially, that perhaps the clearest and transparent way forward for clients is for Fixed Rate Early Redemption Charges to be the only ERCs permitted by lenders.
How is this beneficial to clients and the wider industry?
- Client understanding: A Fixed rate ERC has a defined term. It may be 8 years, 10 years, or 15 years, but there is a clear, defined end point. Many consumers have had residential mortgages in the past, so a fixed rate ERC is something that many understand. Variable ERCs do not have this, other than when a client reached a certain age (usually aged 88).
- A Fixed rate ERC reduces over time: This may be 5% for 5 years followed by 3% for three. The downward trajectory over time is evident, transparent and to the client’s financial benefit.
- A Fixed rate ERC is a known quantity: At the start of the Lifetime Mortgage, the amount and the term of the ERC are illustrated in clear, uncomplicated terms. The client is resourced and confident in the certainty of the charge. There are no shocks along the way.
- The worst-case scenario: The Fixed Rate ERC this unlikely to match the worst-case scenario of a Variable rate ERC which can be up to 25% of the loan if the gilt yield decreases from the time of the mortgage offer to the point when the client wants to redeem more than the permitted 10% per annum.
- Overall client benefit or “balance of harm” test: The highest Fixed Rate ERC on the market is currently 10%, considerably less than the worst- case scenario of 25% for a variable rate ERC.
Supporters of variable Rate ERCs within the Equity Release Advice industry argue for their inclusion for the following reasons:
- Variable rate ERCs may mean a low ERC or even none.
- Only those who do not understand variable ERCs do not like them.
- A client who wants a `gamble’ should go for a variable rate ERC.
- Clients need a choice between both types of ERC.
Undoubtedly, in specific (often narrow) circumstances, a variable rate ERC may be beneficial for the client. Examples include redeeming a Lifetime Mortgage a short period after taking it out as a Fixed ERC bears a certainty of a high ERC. Anecdotally, I am informed that there are times when clients have moved or repaid their Lifetime Mortgage without an ERC. I have yet to have this experience.
Whilst there will be professional clients who understand gilts and are content to proceed with the `risk’ based variable rate ERCs, most Equity Release clients are deemed `vulnerable’ by the FCA and have low to moderate confidence in understanding the risk-based aspects of a product.
Arguably, there are pitfalls to exclusively offering Fixed Early Redemption Charges which perhaps more aligned with the ethics of promoting choice for the client. Would such a change in criteria serve to remove the client’s autonomy to choose and limit the Advisor’s ability to advise accordingly? But would any limitations caused by this `removal of choice’ be outweighed by the associated protections of vulnerable clients through the provision of clear, transparent Early Redemption Charges?
Are Early Redemption Charges the legacy of ‘old style’ Equity Release?
The industry is maintaining that products have been substantially overhauled, with any client complaints or financial disadvantage being attributable to the workings of the `old style’ products.
The goal is not to remove complaints but rather to have greater transparency and clarity regarding the product features.
Whilst it could be argued that it is the job of a competent Advisor to guide the client through the advice process, it is essential that the ERCs are viewed as a simmering threat to the reputation of that industry. If the industry is minded towards infrastructure change for the financial protection of clients against ERCs that can strongly disadvantage them, I believe this is preferable.
This is especially true as the industry expands, with Customers needing reviews on their Lifetime Mortgages that they took out many years earlier. The difficulty with many of the `old style’ products lie with the combination of high-interest rates and variable rate ERCs, causing significant difficulties for those attempting to re-mortgage their Lifetime mortgage:
- The equity in their property has eroded significantly, meaning that the interest rates available to them are higher than the lowest rates available.
- The high (often variable) ERC fees mean that re-mortgaging to a lower rate is not financially viable.
A Lifetime without Review?
Recently, an Ocean Equity Release client wanted to re-mortgage their 6.34% rate on an £85,000 Lifetime mortgage. With the loan to value, a 2.87% deal was available even when adding the over £20,000 ERC to the mortgage balance. After 18 years with that lender, the ERC still represented 25% of the current loan balance. In view of the client’s age and circumstances, it was inadvisable to re-mortgage as it would take too long to recoup the ERC fee.
One option could be for lenders to adopt a fluid approach, treating individuals on a case-by-case basis in removing or reducing disproportionate ERC’s. This would involve an industry-wide collaborative effort that could increase fairness to the client and improve the industry’s reputation. Arguably a discretionary policy change left to the discretion of funders may not be the answer – but it remains essential for a movement towards industry-wide clarity and to ensure we highlight the pain points in the industry and establish greater authenticity and transparency.
A further position may be for future incidents of Lifetime mortgage “prisoners” to be limited or removed entirely. How could this be achieved? -currently, very few Lifetime Mortgage clients are provided with an update, review, or consideration of their circumstances until a major trigger event such as moving home, or death occurs.
As a minimum, the Broker firm and lender could work together to offer clients a bi-annual review to establish whether their Lifetime Mortgage still suits their circumstances.
The True Redemption: Aftercare?
It is essential to consider how regular reviews could support vulnerable Equity Release clients.
Questions that should be asked include but are not limited to:
Is the interest rate the best available rate in today’s market?
Is the client able to pay a lump sum or regular monthly amounts to reduce the effect of compounding interest?
Is Equity Release still the best option for the client?
Is there a change to their personal circumstances and could this affect their mortgage?
What are the Early repayment charges and what is their potential impact?
Driving improvements in the industry: A client-centric approach
In recent years, the Equity Release industry has pioneered substantial improvements and through The Equity Release Council, lenders, and broker firms working collaboratively to identify difficulties and reach solutions; potentially onerous areas can be highlighted, as I have regarding ERC’s and the requirement for bi-annual client reviews.
Indeed, for this trajectory to be maintained, we must move forward authentically, promoting clarity and fairness so that the reputation of equity release as driving towards (and continuing) a transparent, client-centric approach will be established and the public perception of the industry will improve.
We can then move forward to further enhance the reputation of the industry and our client-centric mission to support our clients in releasing capital from their property to enhance their lives.
Contact us if you want to find out of an equity release mortgage is right for you.
Ocean Mortgages Ltd is authorised and regulated by the Financial Conduct Authority.