Once seen as a last resort, the use of specialist, later-life mortgages is increasingly common among well-off homeowners keen to fund “living inheritances” and avoid death duties.
The proportion of £500,000-plus properties being used for “equity release” – as this borrowing is generally termed – has risen at some specialist firms by as much as three times since 2012.
In part this surge has been driven by the booming housing market, particularly in London and south-east England.
However, the growth in the value of the average property used to withdraw cash using equity release or “lifetime mortgages” has far outstripped national house price rises – suggesting that equity release is going “upmarket” as wealthier people embrace it as a broader financial planning tool.
House prices across the country rose by an average of 12.6pc between 2014 and 2017, according to figures from Nationwide Building Society, compared with a 26pc rise in the value of the average house used for equity release (see graph below).
“The increase in the numbers of wealthier, older homeowners extracting cash from their homes through equity release is testament to the fact that those with considerable property wealth are looking to utilise it,” said Dean Mirfin of Key Retirement Solutions, a specialist adviser.
The pension freedoms, a series of reforms introduced in April 2015, have created another incentive to use the plans, said Nigel Waterson, chairman of the Equity Release Council, the sector’s trade body.
As a result of the reforms, people aged 55 or more are able to take their entire pension pot as a cash lump. At the same time, the pensions “death tax” on unspent savings was removed.
Now, instead of pensions being subject to a 55pc tax at death, there is no tax to pay if the individual dies under 75. And only income tax, at the recipient’s marginal rate, is due if death occurs after 75.
This has opened up an entirely new field of inheritance tax planning where the well-off are effectively incentivised to leave their pensions intact and spend other money in retirement – including, potentially, money raised by borrowing against their home.
Financial advisers routinely now tell their clients to spend their other assets such as Isas, which do attract inheritance tax, first, before emptying their pension pots, Mr Waterson said.
“If you’re reasonably well off with a valuable house and decent-sized pension pot it makes huge sense to leave your pension intact to pass on tax-free to your children,” he said.
“Then you can use equity release to give them a ‘living inheritance’, to buy their first property for instance, and to save on inheritance tax.”
The sums removed from properties via equity release schemes have rocketed over the past 12 months. More than £700m was released from homes between April and June this year, the most ever in a single quarter. It is expected that 2017 will see more than £3bn in new borrowing, the highest figure on record.
Equity release plans come in a variety of forms but all involve taking cash – as a lump sum, as income or both – from a home. Typically the loan, which grows with interest that “rolls up”, is paid off only on death. Minimum ages vary between providers but is typically 55. It is mandatory to take regulated financial advice when using equity release.
In the past, taking a mortgage out on homes later in life was seen as a last resort where all other income options had been exhausted. The sector was mired in controversy in the Nineties when thousands found that high interest rates had swallowed all the equity in their properties.
Since then the City watchdog has taken oversight of providers, the vast majority of which now offer “no negative equity” guarantees that mean loans will never be more than the property value.
Interest rates are still far higher than on conventional mortgages but have fallen steadily following the Bank of England’s cut to the official interest rate in August last year. In 2012 the typical loan rate for a 70-year-old was around 6pc, according to Key Retirement, and is now just 4pc. At the latter rates, debts will double in 20 years – at 6pc it would take 10. These figures are based on compounding the interest.
Lenders have also added features that allow borrowers to protect their family’s inheritance by “ring-fencing” equity or paying the interest during their lifetime, which prevents the loan from escalating.
Paying for home renovation is still the most common use of funds released from lifetime mortgages, according to the Equity Release Council, but lenders say it is becoming more popular to use the cash released to help children on to the property ladder.
A spokesman for Aviva, one of Britain’s biggest lenders, said: “We are seeing larger sums of money being accessed in individual cases, which is likely to be a reflection of the increasing number of uses people have for released equity, such as helping both themselves and family and for efficient inheritance tax planning.”
Another popular use of equity release is to clear outstanding mortgage debt as people enter retirement. For many, downsizing may still be the best option.