With an aging world, bank lenders have had to get creative if they want to continue making the same sort of returns they were making decades ago on their home loans. Fortunately for the banks, the perfect opportunity has arisen – the equity release home loan.
However, two factors have occurred which have made repayment home loan less popular in recent years. On the one hand, spiraling house prices in the last decade have meant that the traditional calculation method used in order to approve a repayment mortgage, which was 2.5 times a single income earners income or 3 times a joint income earning salary, no longer provides new home buyers the opportunity to purchase a new home. On the other hand, variable indexed interest rates, which are typically indexed to the central bank's base lending rate, have resulted in borrowers being uncertain of how much they will be required to repay in the near to long-term future.
Having worked all their lives paying into a pension fund they believed would be sufficient to cover them through their old age; many pensioners have since discovered that in fact their pension is not going to be anywhere near enough, even if they do scale-down their standards of living. However, with only the homes they live in as their principal asset, many pensioners are also reluctant to sell and use the proceeds to continue to fund their lifestyle.
With equity release home loan both parties get the best of both worlds. The pension can sell their home to a lender without having to actually move out of the home, while the lender can lend to a borrower you never has to make a repayment.
So, how does this all work? The basics to equity release home loans as that the home owner agrees to sell part of their home (in most cases lenders will not agree to purchase more than 25% of the value of the home) to a lender. In exchange, the lender gives the home owner a one-off payment. The “home loan” is then repaid when either (a) the home owner sells the home; or (b) the home owner dies and the estate of the deceased will pay off the home loan from the proceeds of the sale of the home sale. Alternatively, the heir to the home owner can agree to repay the home loan on your behalf and that way reclaim 100% ownership over the home.
The downside, however, to equity release home loans is the issue of compounding interest. As you will neither be repaying the principal nor the interest accruing on the home loan, it doesn't take too long for the compounded interest on the home loan to start to become a significant sum. In some cases, this compounding of the interest on the home loan can mean that you owe half as much again as you borrowed on the home loan only 5 or so years after you agree to the home loan with the lender. Consequently, very serious and careful consideration does need to be given before agreeing to finance this type of home loan. Here, when reading the home loan agreement, care should be taken to see whether there is a maximum age at which the home loan can be granted as some lenders will not agree to this type of financing package to those over the age of 65. With life expectancy now exceeding this considerably, the interest being compounded could make it feasible that the entire value of the home is eaten up in interest. In that case, you need to ensure that whatever the period of the home loan is for, you cannot be charged more in interest on the loan than the value of the home is on the day that the home is sold to repay the original loan.