The Impact of Falling House Prices on Equity Release
According to data carried out by Lloyds Bank, house prices are set to fall between 2% and 4% in 2024 [1].
So, if house prices are set to fall, what does this mean for those who have released equity from their home?
Naturally, when house prices fall, some people find themselves in negative equity.
This poses a great threat to anyone who owns their own home and is looking to sell anytime soon, or to those who have taken out an equity release scheme.
If you have researched equity release, then you will know that those who take out an equity release scheme need to repay their loan after they pass away via the sale of their home.
Usually, as house prices tend to increase in value over years, the value of your home should always cover the loan amount.
However, if house prices fall then homeowners will fall into negative equity, meaning that they won’t be able to repay their equity release loan.
This is particularly true if you have a significant amount of compound interest added onto your loan.
Whilst this would pose a problem for most homeowners, those who take out an equity release loan will benefit from the no negative equity guarantee, meaning that the lender will always step in if you find yourself in negative equity.
Why have house prices dropped in the UK?
This is a difficult question to answer, as there is no one reason why house prices have fallen recently.
The main contributing factor as to why house prices have fallen recently is due to rising interest rates [2].
If the Bank of England’s base rate increases, then so do providers’ interest rates [2].
Higher interest rates make mortgages more expensive, which means that people have to borrow more.
This means that less and less people will be able to afford to borrow and buy houses. With less demand, homeowners are forced to drop their house prices to entice people to buy them.
Whilst the Bank of England chose not to increase their base rate at the last opportunity to, it still sits at the highest it’s been in over 15 years.
With this, many buyers simply won’t be willing to pay the asking price for houses, forcing homeowners to lower their prices.
The impact of falling house prices
Naturally, falling house prices will have huge consequences for those affected. When we buy a home, we do so with the hope that it won’t decrease in value.
However, it’s important to understand that you cannot control the property markets, and no matter how much you invest in or look after your home, you always run the risk of your home decreasing in value. Below are just some consequences of falling house prices [3].
1. Negative equity
Falling house prices will have a huge impact on the property market. Unfortunately, when your property is worth less, it reduces the amount of equity inside your home.
This means that you might fall into negative equity. Negative equity is when the amount you owe your lender (the amount left on your mortgage) exceeds the amount you would be able to sell your home for [3].
2. Easier access for first-time buyers
Whilst negative equity is certainly scary, it’s not all doom and gloom. Falling house prices means that it’s easier for first-time buyers to get on the property ladder.
This means that more and more first-time buyers will get the chance to buy a house, as long as they have the deposit to do so.
Whilst the house prices might be cheaper, the interest rates will more than likely be quite high, meaning that you’ll need a good job to qualify for the mortgage and pay the monthly mortgage repayments.
3. Tighter qualification criteria
With falling house prices, lenders and mortgage providers are more likely to be more stringent and strict when it comes to their qualification criteria.
This is because house prices might continue to fall, which could leave lenders out of pocket which is greater risk for them. Naturally, lenders will be more cautious.
4. Reduced wealth
A falling property and housing market will also mean that a lot of people will experience a reduction in wealth.
For most people, their home is their biggest asset. So, if this asset falls in value dramatically, then as will their wealth [3].
5. Regional disparities
Unfortunately, some parts of the UK will experience more dramatic drops in house prices than others. This leads to regional disparities.
These regional disparities mean that there will be some social and economic consequences, including some areas struggling from deprivation.
The Impact of Falling House Prices on Equity Release
Falling house prices will have a significant impact on anyone who has taken out an equity release loan.
When you apply for an equity release loan, your lender will carry out a home valuation on your property in order to determine just how much your home is worth and therefore how much equity you might be able to release.
Most equity release lenders are relying on the hope that your house will not decrease in value.
In fact, over the years house prices have continued to rise. However, if they do decrease in value for whatever reason, then your equity release loan will benefit from the no negative equity guarantee.
Now let’s look at a practical example
Let’s say your property is worth £300,000. You decide to release £52,200 to pay for a new roof. You are 55 years old when you take out equity release and you die when you are 85. Thus, the lifetime of the loan is 30 years.
Let’s also assume your equity release interest rate is an annual fixed interest rate of 7%.
Scenario 1
Let’s assume house prices grow by 4.32% per year over this 30 year period.
Since your home is worth £300,00 and you lent £52,200, the loan-to-value is 17.4% when the loan was taken out.
This was calculated using a compound interest calculator, the one we used can be found here.
Over the 30-year period, the loan will have grown from £52,200 to £397,359, due to compound interest.
However, remember your home’s value increased by 4.32% each year over that 30-year period. Thus, your home’s value would have increased from £300,000 to £1,066,961.
The loan-to-value when you die/go into long-term care (when the loan is paid back to the lender) would be 37.2%. Therefore, your children or grandchildren will need to pay 37.2% of the value of your home to the equity release lender.
This means they will inherit £669,602 from the value of your home (£1,066,961 – £397,359), which isn’t bad (depending on who you ask), but I think most will agree that paying back £397,359 on a £52,200 loan probably isn’t the cheapest way to borrow money!
Scenario 2
Let’s assume the value of your home grew by just 2% over the same 30-year period, and everything else remained the same, e.g. an annual fixed interest rate of 7% and a loan of £52,200.
At the end of the loan’s life (when you die or go into long-term care), you will still owe £397,359 to the equity release lender. But now, the price of your home only rose by 2% over that 30-year-period. This means your home is only worth £543,408, considerably less compared to scenario 1 above.
The loan-to-value when the loan is repayable is now 73.1%. Your children or grandchildren will need to pay 73.1% of the value of your home to the equity release lender.
This means your children or grandchildren will only inherit £146,049 from the value of your home, a massive £523,553 difference compared to the scenario when houses grew by 4.32% per year compared to 2% per year.
Conclusions from the above
We hope you see that taking out equity release makes a lot more sense when:
- You are older when you take it out (since less years the loan is ‘live’ means the less it will grow)
- You have the benefit of owning an expensive property already so your children will still get a decent inheritance
- You live in an area where house prices are expected to increase by a decent amount each year
- You don’t have children so don’t intend to pass it on once you’ve died
- You take out a voluntary repayment plan, to mitigate the potential for accrued interest to grow exponentially
What is the no negative equity guarantee?
The no negative equity guarantee ensures that even if your house decreases in value, you will never have to pay off the difference between the value of your home and the equity release loan amount.
Instead, your chosen lender will have to step in and pay the difference. This means that lenders will be out of pocket, meaning that they might have tighter qualification criteria when it comes to approving individuals for equity release [4].
It’s worth noting that, in scenario 2 above, even with a no-negative equity guarantee, you’re children or grandchildren would effectively receive nothing from the value of your home when you die. It would just mean the equity release lender would fail to receive the amount owed under the terms of the contract.
Is equity release the answer?
For anyone nearing or entering retirement, you might find yourself short of cash. This is especially true if you are living off of the standard state pension.
Everyone dreams of enjoying their retirement in comfort. However, for an increasing number of retirees, their money simply is not stretching the way it once did.
For many people up and down the country, this is where equity release comes in. Equity release is the answer for a lot of people, although it should be considered very carefully.
This is because as with any type of loan, there are both long and short-term implications.
For example, taking out an equity release loan will have a huge impact on your loved ones and next of kin(s) inheritance.
With falling house prices, this adds an extra risk when it comes to taking out an equity release loan and means that lenders will be very careful when it comes to who they lend their money to.
If you are considering taking out an equity release loan in this climate, then you will need to speak to an equity release adviser first before making any decisions or applying to any lenders.
Speak to Equity Release Warehouse
If you are considering taking out an equity release loan but are worried about the recent fall in house prices, then make sure you speak to a fully qualified equity release adviser, like those at Equity Release Warehouse.
All advisers at Equity Release Warehouse are on hand to provide you with the advice and knowledge you need to make an informed decision.
Start your equity release journey today by contacting us by calling 0330 058 1579 or by visiting us online by searching for www.equityreleasewarehouse.com.
References
[2] https://www.bbc.co.uk/news/articles/c3g8p440309o
