Awake the beast

SHIP recently completed a consultation paper, detailing the challenges that face the equity
release sector, and the list they compiled is pretty depressing. There is nowhere near enough funding available, we are short of good distribution and potential borrowers are confused by the complex products and their pricing, to name but three.

It must be tempting for non-active advisers and lenders to consign this sector to the ‘small niche' drawer, thinking it too much hassle to get into, and instead to look at other opportunities instead. After all, there has been flat new lending of around £1bn for the past few years, five lenders have pulled out of equity release in recent months, and there is a nagging worry

Neil Forrest, of NRF Consulting, assesses whether recent initiatives to awaken this ‘sleeping giant' of equity release within the mortgage sector go far enough about the reputational problems of dealing with a consumer group that is seen as vulnerable.

However, those who dismiss the opportunity should actually have a good
look at the SHIP paper (on its web site, ship-ltd.org), because, despite not pushing
specific proposed solutions to the issues very strongly, it does summarise some of
the ‘dynamite' underlying statistics that should blow this sector sky high at some
point in future.

I will mention just three of my favourite statistics from the report, all of which point to an almost inevitable future increase in demand from people to raise cash from
their homes in retirement. Ten million working adults in the UK are not saving anything at all towards their retirement (ABI Survey). For homeowners within that group, the only viable option to enhance their living standards above the basic level when they reach 65 will be to
look to their house for help. The current ratio of four workers to one pensioner in this country, is set to change through demographic shift, to two and a half to one by 2035 (Help the Aged).

Do you think a shrinking working population will be happy to pay vastly more
taxes to pay for pensioners' care or will they politely suggest that it's only fair that
seniors should help out here, by using some housing equity?
Around 20% of people aged over 66 still have a parent still alive. Many of these
parents will require some financial support from their retired ‘children'. 

Longevity is a huge success for society, but I'm fairly certain that not many people will
plan financially for that type of liability in retirement. There's also some good anecdotal evidence in the paper about active (and therefore cash hungry) retirements
becoming the expected behaviour for the vast majority of people.

Let's test this concept. Do I think I will want to visit those countries, play those golf courses,
which I have not managed already, when I reach 65, expect to have more free time
and hope to be in reasonable health? It's a fair bet!

But to really shake things up in this sector, and allow it to reach full potential,
there need to be some pretty radical changes and, as a product designer, I think the introduction of variable rate lifetime mortgages is one of these. Why is it that in the UK, we have over 90% of lending at fixed rate, when most of the rest of the world has a dominance of variable? One reason is that SHIP rules restrict the provision of variable rate products, (at least without a cap), as a heritage from the bad old days of home income plans, which were poorly constructed and represented a very high risk to both lender and borrower. In addition, the fear of consequences of uncertain borrower debt escalation is ingrained in the sector, making variable interest a taboo. However, at this difficult time for the industry, perhaps more than ever before, I think it is time to slaughter this sacred cow for good and allow us all to reap some of the benefits from a variable rate product. Consider how many potential new borrowers, who currently hesitate to pay around 6% fixed rate, would jump at a product priced at, say 3% over base rate?

At 3.5% today, I bet there would be a quite a few. (There's good demand in Ireland for
Seniors Money's product that tracks the ECB rate plus 3.5%). The challenge to lenders of hedging fixed rate funds, through swaps or matching with annuities is removed with a variable rate and the cost of this can benefit product pricing and lender profitability. Seniors should have genuine choice in products - removing the availability of variable rate mortgages, which you have had all your working life, because you have turned 65, is almost discriminatory, yet that's what currently happens.

Early repayment charges within a variable rate product can be largely removed or simplified, maybe required only to compensate lenders for set-up costs and applied within, say the first three years, compared with 10 years for fixed rates. Securitisation as a funding route is easier for variable rates. Don't imagine that this method is dead and buried following the blunders that caused the credit crunch - Halifax's recent £4bn UK deal followed five RMBS issues in Australia; all for conventional mortgages, admittedly, but Lifetime could follow in due course.

Lenders will worry, of course, that variable rate products make calculating their
potential ‘no negative equity guarantee' losses (when the loan escalates beyond the
home value at very old age) much harder to do, but there are ways to analyse, assess
and price this risk, as they do in Ireland and Australia.

Advisers would also need to be clear in explaining to borrowers that their debt
roll-up could take different paths in future as interest rates change, but I think most
seniors can grasp this point well. Which? magazine recently complained that people
don't understand compound interest on loans, which seems strange - they certainly
expect to receive interest on their previous year's interest, within deposit accounts,
so let us not underestimate the clients' intelligence - they are generally a bright
bunch with time enough to study things and understand them in depth.

Once you are over the hurdle of accepting the variable rate concept, a whole load
of new product ideas can then emerge - how about a loyalty discount on your
3% margin, reducing this by 0.5% every five years until you reach 1%? Let us also
now permit free partial repayment and full ability to redraw it.
An offset lifetime product also now becomes very viable. A lot of seniors like
to see that nest egg that they have built up, physically sitting in a deposit account, but
would also see the benefit of using this to mitigate interest costs on a borrowing line.
Maybe some borrowers would also like half their loan fixed and half variable, to
save interest costs initially, give a bit more certainty to where the debt might end up
and also to provide greater drawdown flexibility. There are many more ideas.

It is good to see SHIP confirm that it is open to debate on changing its rules
on having fixed or capped rate products only, but the lending industry also now
has to grasp the variable rate concept and move it forward. Sadly, current lenders
in the sector may hesitate to embrace this opportunity, given their culture of
operating in the fixed rate world. If this is indeed the case, it would leave a huge and
potentially lucrative gap for new entrants to the lifetime market - over to you guys!