Roll up and Other Misconceptions

Pete Matthew of Meaningfulmoney has an interesting series of videos on equity release. The one that caught my eye was this published on 24 Aug 2011. He writes,

One of the main concerns for those contemplating Equity Release is that the interest building up so fast, there’ll be no equity left in their home to leave to the kids. Here, I show that it’s really not as bad as all that by looking at some realistic examples.

He then goes through the mechanics of the hare vs. tortoise race between rolled up loan amount and house prices. He also gives examples based on an example case in which there is a house worth £200k, an ERM loan of £50k, a loan rate of 7% and an hpi of 3%, with discrete annual compounding.

His results for the Lifetime Mortgage case are shown in the following screenshot:

The key finding is that it takes an awfully long time for the house price to overtake the loan amount and push the loan into negative equity.

That might not be the whole picture, however.

Now I am not able to reproduce his numbers – my spreadsheet is here – and I find the crossover to negative equity occurs after only 37 years rather than his 48 years. Nonetheless, I accept his general point that if you make these assumptions then the loan hits negative equity a long time in the future. For example, if the borrower is 70 when he or she takes out the loan, then he or she is not too likely to be worried about hitting negative equity when he/she is 118 or even 107 years old.

But how reassuring are these results? To answer that question, consider first that his example is based on a projection into the future and past performance is no guarantee of future performance. So what would happen if house prices were not to rise so much or worse still, were to fall? To make the example concrete, suppose the UK were to undergo a Japanese style house price decline of 1.7% a year for the next 30 or 40 years. In that case, the same loan would run into negative equity in 17 years, and our borrower would be looking at telling the kids that their inheritance had run out by the time he or she was just 87 years old. To me that prospect seems a lot less reassuring.

You may say that I cannot possibly know that UK house prices will follow a Japanese scenario. You would be right, but you cannot possibly know that they will grow indefinitely at 3% either. The point is that none of us know what future house prices will do, so we should factor this uncertainty into whatever plans we make and not rely too much on any single scenario.

The worry is what would happen if house prices perform poorly. What would happen to the kids’ inheritance and how would my care home be financed?

Which brings me to a second issue. In the comments section to the video, Care Giver writes:

You haven`t got a clue about the realities faced by next of kin/power of attorney. It is no longer about inheritance anymore but how you fund complex care arrangements for years/decades, and safeguard the surviving partner. It is about how you cope with strokes, dementia, hip fractures and get the best care you can. Equity release strips assets from the elderly and vulnerable which should go to the fantastic care system we all rely on. As POA1 it is incredibly depressing to manage continuing health crises and care packages whilst nebulous financiers remove asset value at ever increasing rates. I also have to maintain the house at great cost and it is difficult to do mobility conversions which impact value. It is not the applicant but family who have to survive this nightmare product (I have just sold my own house to support my Mum as a consequence). All I see is glossy sickening ads for this product – where is the real story and experience of long term carers out here (numbers growing all the time)? If the profits of these companies were used for care we could transform the crisis we are in.

He/she makes some excellent points.

Pete then responds:

Ugh, sounds like you’ve had a torrid time. I’m not sure the system is at fault, but I wouldn’t dream of belittling your horrible experience. Equity release should only ever be a last resort, and I’m sorry that in your case it has been more of a curse than a blessing. The aim of the video is to deal with one of the biggest misunderstandings around Equity Release which might prevent people from considering equity release as one option.

A nice response, but I still wonder whether the video really puts the ‘how long before I run into negative equity’ concern to rest. Maybe it will be a long time before the loan goes into negative equity or maybe it won’t be that long, but there is no avoiding the fact that equity release involves a punt on the housing market for the borrower (or their estate or POA) – and for the lender too.

And Care Giver writes back:

@Pete Matthew Thanks for the reply. I think it is very much the system at fault – equity release is constantly advertised with healthy pensioners free to enjoy life but there is no focus on the reality and sharp end of the process I have mentioned. People are needing more and more long term care and modified housing. It is not the applicant as mentioned but the power of attorney/family who have to sort this out. This is hard enough (coping with constant crises, strokes, hip fractures, dementia, incontinence – these are the realities) without all assets being stripped away at increasing rates. There is a complete shut down on the publication of these downsides (I have had comments mysteriously removed when I raise the subject) but they will come to light as more struggle with these issues. The money made by these companies could transform the care system. It has destroyed my life and will do others trying to look after their parents for years to come. My father never envisioned needing 10 years plus of care packages and the devastating effect it would have on his family. If he had the full picture he would never have taken out equity release.

So to spell it out, if an individual does not ERM their property, then that property can be used to provide for their long-term care, should it come to that. But no one with equity release will be able to do the same, so many people will be falling back on council support, with councils already struggling to fund care provision, and with medical science increasingly allowing us to live to an advanced age, i.e. an advanced age of incontinence, dementia etc.

As the equity release industry and the powers that be push the product hard, the points raised by Care Giver, i.e., the cons (and note the multiple meanings of that term) as well as the pros of equity release, badly need to be discussed. Perhaps this is one for Age UK.

  1. Power of attorney