Equity release schemes promise to make the financial problems of elderly homeowners magically disappear, but Eddie Hobbs is not convinced. In this exclusive article, he argues that such schemes have serious drawbacks, and that other options must be considered first.

Asset-rich and income-poor isn't just coded language these days for a generation of farmers, but invokes strong feelings among Ireland's far less vocal retired population. Given the scale of rises in property values over the past 15 years or so it was inevitable that Home Equity Release schemes would mushroom here as they've done in other countries. But are they good value, when should they be used, how do they work and what are the pros and cons?

Such questions are not easy to assess if you're elderly, out of cash, scared about what's around the corner or ill-equipped to unravel some of the most emotionally and financially-complex products ever devised. The meeting of sizeable, skilled and well-heeled financial firms with, arguably, the most vulnerable element in our population has the Regulator, the Law Society and other observers quite concerned. But you too should be concerned, if this is the type of scheme your own parents may be considering, rather than burdening you with their worries.

Already thousands of Irish retired people have taken the largely one way ticket that these schemes represent, where the ownership of their homes is at stake. Despite the glossy brochures promising holidays in exotic locations festooned with positively athletic-looking retirees, the harsh facts are that lots of the cash is being spent on home improvement and on debt consolidation. So what's on offer?

Equity release - the options

There are two types of equity release scheme. A reversion scheme, which falls outside financial regulation, is a straight property purchase agreement, but the offers made are heavily discounted to take into account today's long life expectancy. Let me give you an example to help get your head around it. Say your folks' home is worth EURO 500,000 and they decide to sell half of it. You might think they'd be offered something close to EURO 250,000 as a couple in their early sixties. In fact, they could expect more like a fifth of it - about EURO 100,000. Surprised?

The alternative is a mortgage linked to life length, the interest on which ramps up in the background on the original balance. That way, no monthly repayments are made, which the ads make a big deal about. What the ads don't reveal is that the interest rate is way above standard mortgage rates, which stand today at about 6 per cent. This means the debt doubles every ten years or so. The maximum loans for the same couple would be about 20 per cent of the home value, so you're back again to EURO 100,000 on a EURO 500,000 property. But by the time they are in their mid eighties the debt attached to the home will have quadrupled, and gone up eight times by their mid nineties.

Longer lives and relatively low interest rates drive the pricing by the Home Equity Release vendor and the return for the user. Two hundred grand rolls across the lips sweetly when you're low on cash but what is its true worth as an income stream for life? The table below tells the tale, revealing that the phased withdrawal of interest and capital on EURO 200,000 over thirty years has a value of a little over EURO 8,000 or 4 per cent. This assumes that the money is invested where it outpaces inflation by a net 1.5 per cent per year. In practice lots of people just leave cash in deposit accounts many of which under-perform inflation and fully exhaust themselves earlier.
        
Home Equity Release Sum: EURO 200,000
Years to Exhaustion: 30 years
Net Growth on Money: 4.5%
Phased Draw Down: EURO 8,157.56 escalating at 3% p/a

There are alternatives

The easy access to cash is the obvious attraction of Home Equity Release schemes and they are, unquestionably, valuable as the last parachute on the plane. After all, if it's going down who cares if the parachute is Hugo Boss or Primark? But these schemes have so many holes in them, your folks should have exhausted all possible alternatives first.

Downsizing is one option, coming with the added benefit of a fresh starts, no debt on the new home and modern insulation and fittings (see Downsizing in Style panel). Parents don't generally need huge dollops of cash and it may be within the means of their adult children to organise regular income support.

Ideally, income support of this kind should form part of tax incentives rather than coming from after-tax income. A buy-out structure could also be considered, whereby the adult children purchase the family home, leaving their parents as life tenants with the cash typically raised from mortgage finance. This cuts out the middleman's profit and delivers a better deal.

Law Society concerns

But not everyone may find they've room for manoeuvre, and entering the Home Equity Release market may be the only option left. Apart from the value aspects of these deals, be aware of some of the things the Law Society is concerned about.

For example: on the mortgage deals, many conditions are not standard to normal mortgages, such as forcing borrowers to make wills, or making executors undertaking to co-operate with the bank. There can be compulsory disclosure of beneficiaries, and the banks can have the right to bypass the borrower and discuss the mortgage with executors and beneficiaries. These are not just superfluous to bank security but appear offensive to Article 8 of the European Convention on Human Rights which states that: "Everyone has the right to respect for his private and family life, his home and his correspondence."

The Law Society has concerns about the scale and complexity of redemption charges where these mortgages are repaid. Most of these charges allow the bank to recover the lost future profits from the mortgage, even though it has already benefited from high lending margins. While these fees may not be offensive to the Consumer Credit Act they appear offensive to Unfair Terms Legislation. Other deals allow the bank to call for full repayment or to sell the house during the borrower's lifetime if the bank forecloses on a different property owned by the borrower.

The Law Society is also unhappy with inducements like cash payments for wrapping up deals quickly, or with conditions in reversion schemes that prevent a surviving spouse who remarries from allowing his or her new spouse to reside in the home without reversion company consent.

So unlike the image portrayed by the soothing voice on the radio, these deals are not as they seem. Home Equity Release is not a fitting financial end for Ireland's cash-strapped pensioners, especially when adult children may have the resources to prevent such an outcome, or when downsizing opportunities exist.

The Generation Gap

The issue of equity release is a reminder that, for the generation that is benefiting so handsomely from the current economic climate, it is vitally important that they give due consideration to their parents, who have observed the great blossoming of wealth in Ireland over the past decade. They were weaned in an Ireland that told them that sacrifice was the gateway to riches of the soul. They put everything before themselves, and did everything for the children.

Now they're elderly, and those who don't have gilt-edged private pensions are in financial trouble. But they don't share that worry. They don't want to impinge on the success of their, the tiger cubs. Money is something the family never discusses when they get together for christenings, communions, and weddings. It's an unwritten rule. They ask their adult children how they're doing but never invite questions about themselves. They still turn up with bundles of Christmas presents and they never forget a grandchild's birthday. But did you ever wonder, as the present is unwrapped, how much the precious gift has eaten away at their sense of financial security?

How many of us, honestly, know how much our parents have left in the pot or how much they need to finance a modest lifestyle in an Ireland that eats into retirement savings with a savagery unparalleled in any other European economy? Yet as Ireland became richer it's obvious they've become poorer, with few assets and meagre pensions. The adjustments to the Old Age Pension were never enough to offset the rampaging cost of living and, even if you do fully qualify, at a little over ten grand for one person or fifteen grand for a couple, it's still less than half the average industrial wage, technically below the poverty line.

Lacking experience with the more complex financial products of the modern era and horrified at the thought of capital losses, they cling to bank deposits. But after deducting Irish inflation they've been experiencing steady erosion of their financial strength, year by year, as the Tiger prowled. Now, many of our parents, those responsible for laying the foundations of our much-vaunted education system, are outliving their savings because they are living longer than their own parents did. And in this widening void between retirement and death what has Ireland done for them to encourage supplements above the Old Age Pension?

So far we've abdicated our responsibility to our parents by encouraging them to invest in commercial schemes like Home Equity Release that make a profit from them. We've left many of them with little choice other than pledging chunks of their homes to private schemes or taking out mortgages - in their seventies, for Heaven's sake - that double in size every ten years.

Surely we can do better? Of course we can, although unless we're prepared to pay tax at Swedish levels, there will always be a limit to Old Age Pension payments, fuel supplements and nursing home subsidies. But what about the private sector - what about us, the adult children?

It seems long past time for the Government to give a tax incentive that encourages adult children to transfer money to their retired parents, to at least bridge the gap between the OAP and the Average Industrial Wage. The tax revenue lost in income tax would be regained in VAT spent on essential purchases by parents.

Surely anything is preferable for our parents than the indignity of outliving their savings or surrendering their homes to private companies rather than to their children and grandchildren?

Michael and Celine live in a semi-detached house in South Dublin. Michael retired with a modest pension of just EURO 6,000 a year. They've two adult children both in their thirties: daughter Ciara is recently married with two young children; Sean works with an NGO in Africa. They rarely see him these days.

Like many his age who didn't work in the public sector, Michael's employer only began to beef up its pension scheme after being forced to do so following changes to the law in the early 90s. The six grand came from a pension fund value of just under two hundred thousand that had accumulated by the time he retired, on medical advice, at 60. That was six years ago and the tax-free cash lump sum he got has been whittled away paying expenses ever since.

The problem now is that the house needs at least EURO 20,000 spent on badly-needed modernisation, but when his private and State pensions are added together the combined income of EURO 21,000, despite rigid budgeting, already falls short of their spending by at least five thousand. They've found the last five years scary, as costs have risen beyond their means and they have started to accumulate debts. When a term loan, a credit card and a store card are added, the debt runs to EURO 12,000. This might not sound like a lot, but it represents around 60 per cent of their year's income when they're already struggling with repayments.

They heard about Home Equity Release Schemes and reckoned that freeing up some of the value in their home, valued at EURO 1.2 million, might be just the ticket. That was until Michael and Celine read the small print. A reversion scheme would pay them about EURO 250,000 but that would mean giving away half their home, or EURO 600,000 in value. Michael already knows from his old pension fund that a quarter of a million might sound like a lot, but it would only translate to an extra annual income of a little over EURO 8,000 if kept on deposit, losing value each year against inflation. They figure that for giving up EURO 600,000 that's a pretty poor exchange.

Reverse Mortgage Schemes don't really improve the picture. The maximum borrowing for their age level of 20 per cent would mean a lump sum of EURO 240,000, but with interest running at about 6/7 per cent p/a the debt would double every ten years. By their mid-seventies they'd owe EURO 480,000 and over a million by their late eighties. Michael just doesn't like the idea of a mortgage debt guaranteed to rise at 6 per cent p/a while house prices stagnate because it would erode the equity in their home.
Celine hasn't been idle; she's been looking at buying a brand new home close to the area. They don't need all the extra space and she'd prefer a home without stairs these days anyway. They figure they can comfortably downsize to a new home with all mod cons for about EURO 700,000 or so. They reckon that beats the socks off Home Equity Release. They'd bypass the middleman's profit, own their home 100 per cent, have no debts and around EURO 430,000 left over after paying costs and taking a trip to Africa to see Sean. The sign is up on the old place with early offers showing promise. Meanwhile Celine is back in the catalogues planning her new look - she's going for something Moroccan she says!