People are living longer, and life expectancy is rising further. In the U.K., life expectancy increased from 70 years in 1961 to 80 in 2009, and 1 in 3 babies born in 2013 are now expected to live to celebrate their 100th birthday.
It is therefore no surprise that people are increasingly concerned about how they will fund retirement and healthcare needs in old age. Inadequate pension provisions coupled with low interest rates have hit retirement savings; a new generation of workers have not had the advantage of a defined benefit scheme, and living costs have increased for U.K. households from an average weekly spend of £507 in 2012 to £531 in 2015.
All of this has placed pressure on limited disposable incomes in retirement, which does not look set to abate in the future.
Lifetime Mortgage Lifeline
Property prices have, however, given some homeowners a lifeline. House prices have risen from an average of £62,333 in 1993 to £247,000 in 2015, an increase of around 400%.
This equity buffer can be released by homeowners to help them fund retirement and healthcare into their old age. This equity release product is known in the U.K. as a lifetime mortgage, and in North America as a reverse mortgage, equity release mortgage, or a home equity conversion mortgage (HECM).
The lifetime mortgage product allows elder homeowners to convert part of their equity in their property into cash, without the disruption or expense of moving homes. Usually, the lifetime mortgage works on a “roll-up” basis, whereby the borrower receives a lump sum with interest charged on the loan. However, the interest is not paid monthly but rolled up on a compound basis, to be paid off in full when the borrower either dies or the home is sold.
Broadly speaking, there are three types of lifetime mortgages available in the U.K., which all function slightly differently:
Roll-Up Lifetime Mortgage
The borrower does not make regular payments but instead a lump sum is paid when the property is sold, or upon the borrower’s death. The borrower may also arrange for a pre-agreed cash facility in addition to the lump sum taken.
Interest Only Lifetime Mortgage
Similarly to a traditional interest-only mortgage, the borrower makes monthly interest payments, and the original amount borrowed is paid off when the home is sold or the borrower dies.
Fixed Repayment Lifetime Mortgage
The borrower receives a lump sum payment, or a regular income, but there is no interest build-up. Rather, the borrower agrees on a set repayment sum that must be paid when the property is sold or when the borrower dies, regardless of when the loan was granted.
Risks to Borrowers
The major risk for borrowers, or their beneficiaries, is that unless they have a “no negative equity” guarantee within their lifetime mortgage, they could eventually owe the bank more than the market value of their home.
Furthermore, with products such as the fixed-repayment lifetime mortgage, the borrower would receive very poor value for money if they passed away earlier than anticipated.
Living longer also poses a risk, as borrowers who take out lifetime mortgages in their 60s could find that they outlive their loan funds.
Finally, as with all mortgages, the borrower risks having their home repossessed if their retirement income becomes insufficient to maintain repayments.
Risks to Banks
The risks to banks are also considerable. With people living longer, the duration of the mortgage is fundamentally uncertain. Even if the borrower lives to 100, they do not have to pay until they leave the home, which could potentially tie up funds for banks for over 40 years.
This longevity risk is compounded by the house price inflation risks accepted by the bank, which makes it liable for any loss that occurs if the house price depreciates below the repayment value of the loan.
Other risks include borrowers allowing their home to fall into serious disrepair, which would damage its market value for the bank when looking to sell the property on the borrower’s death.
Finally, regulatory and reputational risks are naturally inherent, particularly when trust in financial institutions remains low. If the need to foreclose arises, banks may be seen to be pushing vulnerable pensioners out of their family homes – not ideal headline material.
Whereas borrowers in the U.K. must ensure their loan contains a “no negative equity” guarantee to prevent repaying more than the market value of their home, in the U.S. and Canada this guarantee is inherent within the reverse mortgage product. This is because in these countries the product is a non-recourse loan, i.e. the lender has recourse against the property only, not against the borrower personally nor their estate.
However, the industry has still found itself under intense scrutiny; in the United States, the Consumer Financial Protection Bureau found that the complex nature of equity release mortgages could result in severe financial problems for the elderly.
The Future of Lifetime Mortgages
However, fees have been lowered, consumer disclosure has improved and A-list lenders have expanded their presence in the market.
Ironically, now that the industry is cleaning up its act, lenders in the U.S. are finding borrowers hard to come by. Volumes of reverse mortgages are off nearly 40% so far this year, and are on an annual pace to record only 70,000 transactions nationally for the whole of 2015.
Conversely, in the U.K. the value of lending via lump sum lifetime mortgages increased by 18% year-on-year in Q3 2015 to reach £183.5 million, the biggest figure since 2006. Drawdown lifetime mortgages also rose by 18% to a new high of £266.8 million.
There is no panacea for the crisis in retirement, but lifetime mortgages may prove to be a solution for some home-owning customers. Borrowers will need to continue to ensure that these products are suitable for their financial needs, and lenders must continue to be transparent with customers to maintain the integrity of lifetime mortgages over the coming years.