Inflation & rising interest rates: What does it mean for equity release?
Against a backdrop of rapidly rising inflation and bank base rates, the equity release market has seen a series of upward interest rate movements in recent months.
With an uncertain economic outlook likely to drive even more price volatility in the near future, what does this mean for the cost of borrowing, the relative attraction of later life borrowing to consumers and the success of the market itself?
A common myth
Perhaps one of the common and pervading myths about equity release is that it’s an expensive form of borrowing.
The compounding effect of rolled-up interest, potentially high exit charges due to gilt-based ERCs as well as a relatively small pool of available lenders and lending options gave a historical impression that equity release was a niche borrowing option of ‘last resort’.
Modern equity release
All of that changed in the second half of the last decade, and rapidly so. An exponential rise in lending options, the introduction of modern lending features (including the increasingly popular ability to repay capital without penalty to help manage debt levels) and falling interest rates drove a sustained boom in business that only a global pandemic would ultimately stifle, and even then only temporarily.
By the final quarter of 2020, rates in the equity release market had hit historic lows, with deals available at AERs from around 2.3%. When you bear in mind that these rates are fixed for life, combined with the effect of long-term HPI, which generally drives house values inexorably upwards, this meant later life consumers had an extraordinarily attractive and cost-effective way of financing their retirement.
The market today
Today, those rates are gone. The impact of the wider economic landscape has pushed rates into higher AER territory. Equity release interest rates are not governed to quite the same extent by the factors affecting residential mortgage rates. Minor movements in Bank of England base rates don’t necessarily translate into rate changes in the equity release market, for example.
Nevertheless, the perfect storm of economic influences right now - rapidly rising inflation, the cost-of-living crisis, and the effect on long-term gilt and swap rates caused by everything from the Mini Budget to the war in Ukraine - have all played their part in pushing equity release rates up.
How rates have changed
If we look at average rates from September 2020 - when rates in the equity release market began to hit their historic lows - and the average rates available today, you can see the shift more starkly:
Average AER* Highest AER # of products
1 September 2020 3.98% 6.50% 457
1 September 2022 5.96% 7.55% 593
Based on Key Group data
If we consider the impact on the cost of borrowing, one handy rule of thumb is the Rule of 72: divide 72 by the interest rate to get the number of years it will take for the debt to double (based on the compounding effect of interest not being repaid).
So, at 4% AER, debt will double every 18 years (72/4). At 6%, that falls to 12 years.
The overall cost of later life borrowing is an important part of any discussion between an adviser and their client. Given that, typically, interest is not repaid on a lifetime mortgage, the impact of a higher interest rate on the potential size of any estate a client will leave behind for loved ones is going to be influential in the decision-making process.
A strong market
However, even as rates began to rise in 2021 and throughout 2022, the equity release market has continued to flourish. 2021 was a record year for lending (£4.7bn) and 2022 is set to break that again with perhaps as much as £6bn of lending based on current run-rates.
Consumer confidence and interest in later life borrowing has never been greater and, if anything, the background of individual as well as familial economic pressures is fuelling some of this demand.
As people on fixed retirement incomes struggle to make ends meet, children struggle to raise the deposits required to get on the property ladder, and debt (especially unsecured debt, such as credit cards) soars amongst the over-55s, equity release is still a viable and financially attractive solution to many – including, of course, the ‘Bank of Mum and Dad’.
Although average AERs are now above 5%, compared to typical mortgage Standard Variable Rates (SVRs) - which now sit at 5.4%** - these fixed-rate, long-term borrowing options still represent great value for money for those seeking a flexible way of financing retirement and those looking to refinance existing mortgage debt.
The importance of expert advice
As ever, specialist financial advice is absolutely critical. Those seeking to refinance and perhaps use debt as a way of bridging gaps in later life finances need expert advice to ensure they get the best outcome and avoid making bad long-term decisions that provide only short-term financial relief.
With the right help and advice, later life borrowing looks set to continue to play a critical role in the financial outcomes for the over-55s in the UK.