Why now might be the worst time to take out an equity release loan
Mortgage advisers are warning over-55s who want to release equity from their homes to “hold tight” amid fears of a housing market crash.
Years of property price growth have fuelled an equity release boom. Total borrowings rose to a record £6.3bn in 2022, up by almost £1.5bn on the previous year.
But experts are urging older homeowners to think twice before taking out a loan due to forecasts that house prices will drop between 5pc and 20pc over the coming years.
Jane King, of financial adviser Ash Ridge Private Finance, said falling house prices were “always a risk” when taking out equity release. “It is one of the things clients are most concerned about when they approach me,” she said.
Borrowers locked into high rates are particularly at risk in the event of a house price crash.
Equity release rates soared last year in the wake of Kwasi Kwarteng’s mini-Budget. Currently the average rate on the market is 6.76pc. Last summer a 5pc rate was more typical, according to Ms King.
“I’ve had clients ring in since Christmas interested in releasing equity for things like home renovations and I’ve told them to sit back and wait," she said.
Dean Buckner, of the UK Shareholders’ Association, said borrowers taking out equity release at today’s rates could see their assets “wiped out entirely if house prices decline”, leaving them “increasingly vulnerable as they get older”.
Homeowners release on average about £100,000 from their properties according to data from equity release firm Key.
The initial sum is usually paid back on death or when they move into long-term care, along with interest which compounds over time.
Under the “no negative equity guarantee” which lenders introduced in 1991, borrowers can never owe more than the value of the property.
However they nonetheless risk losing the entire value of their home because of the way the debt rolls up.
How quickly this could happen depends on four factors: the rate of interest, the loan-to-value ratio, the borrower’s life expectancy and, finally, house prices.
If a homeowner borrowed £100,000 out of a £250,000 property – an LTV of 40pc – at a rate of 6pc, it would take 16 years for the debt to eat up the value of the house.
But if the price of the property fell 20pc, then all the equity in the house would be gone within 12 years – 10 if they had borrowed at a 7pc rate.
Lenders have reacted to house price forecasts by restricting how much homeowners can borrow, to reduce the risk of clients hitting the no negative equity guarantee.
Kelly Melville-Kelly, of the Equity Release Council, a trade body, said: “Lower house price expectations generally result in lower LTV limits, meaning customers can access a smaller percentage of their total property wealth.”
This time last year the highest LTV available was 59pc, according to the financial analyst Defaqto, compared to 53pc today. Such high LTVs are generally reserved for those aged 80 or over.
Andy Wilson, a financial adviser, said “waiting is probably the best option” for those unable to take out a larger loan due to expected house prices and reduced LTVs.
Even though lenders have brought down their maximum LTVs – in some cases by as much as 18 percentage points, according to Defaqto – borrowers aged 60- to 70-years-old are still able to take out loans at LTVs of 30pc to 40pc.
High LTVs are risky for younger homeowners because the younger a borrower is, the longer the interest has to roll up.
Ms King said that sometimes lenders will charge a higher rate if a younger borrower asks to borrow more.
She said: “A homeowner might have an offer of a 5pc rate to release 20pc from a £200,000 house and then decide they want 30pc, so the lender will up the rate to 7pc, which is quite expensive. And if you’re 60 there’s a chance you might live for another 30 years.”
If a 60-year-old homeowner borrowed £90,000 from a £300,000 property (a 30pc LTV) at a rate of 6pc, they would lose the value of the house by age 81 and at age 76 if they borrowed at a rate of 7pc.
Ms King said homeowners were better off waiting until rates came down, adding: “There will always be people who are desperate for the money but I would tell those who need a loan to borrow as little as they can while rates are this high. They can always borrow more later if they wish.”