“On 2nd August 2015 The Sunday Times published a story regarding a complaint that was not upheld by the Financial Ombudsman Service, about an early redemption charge on an equity release product.
“While the exact product and companies involved have not been disclosed, and Andrew Castle has not responded to our attempts to contact him, subsequent reporting has been misleading. It reveals extensive confusion about the charges on equity release products, specifically how early redemption charges can be incurred and how interest is applied.
“We are very proud of what the industry offers and the rigorous standards in place which help people access advice and products to improve their quality of life in retirement, as many customers report. Equally, we are not complacent and take matters of advice and understanding equity release very seriously, through the work of our independent Standards Board and regular discussions with the Regulator and Ombudsman.
“With that in mind, we are extremely concerned that needless anxiety is being created and are seeking to provide clarity on queries regarding downsizing, early repayment charges, interest and the advice available to consumers.”
1. The regulation of the sale of equity release products
Equity release has been regulated by the FCA (formerly FSA) since 2004/5 and is one of the most tightly regulated financial services products in the UK. The only way to purchase one of these products is via regulated and qualified financial advisers
Prior to this, members of the Equity Release Council (formerly SHIP) established a set of practices and safeguards in 1991 to ensure their customers receive an accurate, fair and comprehensive overview of their equity release options. Involving both qualified financial advisers and independent legal representation, this highlights important considerations such as costs, interest rates and other charges such as fees and early repayment charges (ERCs), the implications of moving, taxation and the effect of changing house prices.
The industry rules and guidance specifically require advisers to explain the impact of any compound interest, ERCs and the fact the opportunity to move the loan in the future is available, but will be restricted to properties acceptable to their provider.
Customers are also encouraged to discuss the matter with family at their own discretion, to avoid surprises or misunderstandings further down the line. The Ombudsman has informed us that there is a low level of complaints about equity release; the majority come from family members where this step has not occurred; and the majority are not upheld.
Over 90% of plans taken out are from providers who abide by the SHIP standards – a rigorous consumer protection framework that also includes a no negative equity guarantee and the guaranteed right of tenure.
2. How equity release products work
Equity release enables a homeowner to release a cash sum (or sums) from the value ‘locked up’ in their home. This sum is provided by a financial services company and as with most borrowing, interest is payable. However, unlike a mortgage or personal loan, no interest is payable on an equity release product upfront, to maximise the income available to the homeowner.
Instead, interest is accrued over the borrowing term, and is due to be repaid when the client’s property is sold upon death or a permanent move to residential care. However, all products are portable, subject to the provider’s terms, and there is no early payment charge for moving house (see 4).
3. What are ERCs and why do they apply?
Lifetime mortgages are designed as long term commitments by both the customer and provider, which have no fixed end date and typically remain in place until the customer passes away or moves into permanent care. There is no ERC involved when customers move into long term care.
An ERC may be required if customers want to repay some or the entire amount they borrowed before they pass away or move into permanent care. This is because the provider also has to pay a cost to exit the arrangements that were set up to fund the loan, which guarantee a fixed rate for its duration. This is the same principle as exists for fixed rate, fixed-term residential mortgages.
ERCs are clearly documented during the advice process so customers can see whether a charge may apply, when this is applied, how it is calculated and the maximum amount in money terms that it could amount to.
4. Can you move a loan to a different property without incurring an ERC?
Yes. If a customer is looking to downsize, they can ‘port’ their loan to a suitable property without incurring a charge. Even if some of the loan must be repaid because their new property is of a lower value, there will be no ERC unless they want to repay more than they are required to. If a customer wants to do so, the ERC will only apply to the extra amount above the required repayment.
5. Why is compound interest used for equity release plans?
Compound interest is seen by the Regulator as the fairest method to charge for a loan where the customer does not make repayments until the loan ends. This is because the true cost of borrowing is higher, as the provider cannot use repayments to generate interest as they do with other financial products.
The alternative to compound interest – a flat annual fee – would result in a much higher rate for equity release borrowers to reflect the true cost of borrowing. Some recent equity release plans allow monthly repayments before switching to roll-up at the choice of the customer: where monthly repayments are made, simple interest is used instead of compound interest.
The Key Facts Illustration which customers receive before committing to a loan clearly sets out how compound interest will increase the amount owed over 10 and 15 years.
