Relax Equity Release Affordability Rules

Relax Equity Release Affordability Rules.

The Equity Release Council (ERC) has suggested that the finance industry regulator, the Financial Conduct Authority (FCA) should relax its rules on mortgage affordability for pensioners and equity release schemes.

Following the credit crunch crisis the financial services industry was given a big overhaul with regard to mortgage lending resulting in the Mortgage Market Review (MMR) which put a greater onus on mortgage brokers and lenders to ensure that all mortgages were suitable and affordable. Affordability does not just mean being able to afford your mortgage today but also mortgage lenders applying stress tests such as reduced income or increased interest rates to check that you will still be able to afford the mortgage payments in more difficult times.

This has presented a significant barrier in the development of the equity release market hence the call by the ERC.

There are basically three types of equity release scheme:

The lifetime mortgage: where no interest payments are made on the amount borrowed, this is added to your debt and your debt gradually increases. This is repayable either on sale of the property or death. This is not affected by the affordability test.

The home reversion scheme: when no interest payments are made whatsoever and no rent is paid but you sell a proportion or the whole of your property and live there “rent-free” for the rest of your life. The equity release company makes its money when the property is sold and retains either its share in the increased value of the property or the whole value of the property if you took out a 100% home reversion sale. This is not affected by the affordability test.

The retirement mortgage: this works in exactly the same way as any other interest only mortgage. You release equity i.e. borrow some money and then you make monthly interest payments. This way your debt does not increase and in theory you owe the same amount that you have borrowed on the day that you either sell the property or pass away. Because there are interest payments to be made each month there is an affordability test.

This is why there is a problem as many pensioners are on fixed incomes with level annuities or they are spending their pension fund using flexible drawdown with a risk that the value of this could rise or fall in the future depending upon investment performance. The affordability test is strict and therefore many pensioners are not able to afford a “retirement mortgage” based upon lenders tests. This is exactly the reason why the ERC is asking the regulator to relax its Mortgage Conduct of Business rules.

Comment

For the equity release market to develop innovative products, providers must work with the regulator to tackle hurdles such as affordability. Whether the government or the regulator likes it or not our home is usually our biggest asset and by offering greater flexibility on affordability tests for pensioners taking out a retirement “interest only” equity release scheme it may ease the burden on the state not just for benefits such as pension credit but also provide flexibility to release funds to pay for care fees costs.

The rules on equity release should not be so rigid that a lender can be held totally accountable if a pensioner cannot subsequently afford the interest payments on a retirement mortgage. There must be some allowance to enable a simple switch from the interest payment scheme to the interest rollup scheme (lifetime mortgage) without major restrictions or penalty. We are an ageing population with an ever increasing burden on both the health service and local authorities for care in older age and a more pragmatic approach is needed.