The downsizing deniers

I spoke at an event on Scottish independence in London this week – the first time I have done so in the south. The audience wasn’t particularly interested (“why should we care”, asked one) until someone on the panel noted that a vote for separation might mean a collapse in Scottish asset prices and a nice opportunity to pick up a few grand Georgian townhouses in Edinburgh or Glasgow for peanuts. Then they perked up nicely.

That reminded me yet again that if there is one thing that every single Brit likes to talk about (regardless of the actual topic in hand), it is house prices and how to make money from changes in house prices.

There’s a lot to talk about at the moment. The latest reports show prices rising by 17% in London and 8.7% across the UK (Halifax). Anecdotal evidence suggests that gains in London are slowing slightly, and those elsewhere picking up.

For now at least, the bull market is back. You will hear many good reasons why this shouldn’t be so (often from me, when it comes to London at least), but the case is well summed up by the analysts from Fathom Consulting.

They point out that the great British housing shortage is obvious everywhere “except for in the numbers”. In 2012, the number of dwellings in the UK rose by 0.6%. So did the population. But that stability wasn’t just evident in 2012: the amount of housing per capita has been stable for the past 15 years.

If there were really a shortage of housing, rents would be rising rapidly in real terms. “They are not.” That tells us that, in the UK at least, the high level of house prices isn’t so much a function of this perceived shortage of supply as one of super-low interest rates and subsidised access to mortgage credit.

I suspect that for a lot of you the answer to Fathom’s careful analysis would be “why should we care?” It doesn’t matter why prices have gone up; they just have. That’s made a lot of people very rich on paper and, based on the questions you ask me, created a conundrum a lot of you care about significantly more than you care about this year’s actual movement in house prices – how to release some of the equity from your already expensive houses.

What do you do if you live in a very valuable house in London or the south east, you have very little else in the way of wealth or income, but you want to have some money to spend or to give to your kids now to cut their eventual inheritance tax (IHT) bill. The obvious answer to this lucky-people problem is to stop living in the expensive houses.

If you bought something for £6,000 35 years ago and it is now worth £2.3m, sell it, buy something smaller or something somewhere else for £1m (that’ll get you a grand Edinburgh townhouse). Keep a couple of hundred grand for fun; shovel the rest to your kids; and then try and live for another seven years to make the gifts IHT free. Easy really.

Except that it isn’t the answer most people want. They want to have it all – they want to stay in the house and have the cash too. Think of them as ‘downsizing deniers’. This is where the equity release industry comes in.

They offer two main choices. You can get a home reversion loan – where you effectively sell a percentage of your house to the equity release company at a discount (you might have to give them 60% of the value for an advance of say 20% of the value), and they get that percentage outright when you sell.

Or you can get a lifetime mortgage where you borrow a certain amount of money against your house at a set rate of interest. You don’t pay anything back until you sell or die, but at that point, the original capital plus the compound interest is paid back in full.

Sounds brilliant, doesn’t it? It allows you to stay in the house, but also do the above (spend money, give money away, avoid IHT). But should you actually do it?

It’s a finely balanced actuarial bet – one you are taking against people who will probably have done the numbers rather better than you have. Let’s say you are 70. You have a house worth £2m. You take out a lifetime mortgage for £700,000 and give the cash to your children. The interest rate you get is likely to be 6.5% at the lowest (equity release rates are – inexplicably – much higher than ordinary mortgage rates).

Let’s say you live in the house for another 15 years. The miracle of compounding means that, while you have avoided IHT on £700,000, your estate now owes over £1.8m. House prices and inflation might have gone up substantially in the meantime, making that lost cash seem like small change to your heirs. Or, if Fathom is right, they might not have.

Now let’s say you die in four years. Your interest bill is already around £200,000. And you still have to come up with 60% of the tax liability on the £700,000 you gave away (your IHT liability is tapered out to seven years after a gift at which point it falls away). Assuming you’ve used up your nil-rate band elsewhere, that’s nearly another £170,000. Total bill? £370,000. Over 50% of what you gave away.

IHT is 40%. It would have been better for your children if you’d never given them the money in the first place. You can make all these calculations a lot more complicated. Once you are over the nil-rate band, as here, you can take into account the fact that the money spent on interest is money that no IHT will be due on.

You would have had to pay £80,000 in IHT on the £200,000 (assuming no other complications), so you can say that the net cost of the interest is not £200,000, but £120,000.

This changes the calculations for the first seven years of the deal and makes it look financially efficient for a few years (in this example, years six and seven come out looking good). But this still means that the vast majority of years look pretty bad. And who can time their death in this way?

You can also complicate things by assuming various rates of return on the gift. If your heirs can invest in the released cash well and you can live beyond the seven years necessary to avoid IHT, you can manipulate a spreadsheet to make equity release look pretty smart.

However, you must note the ‘ifs’ in these comments – the compound interest is a given, everything else is a guess.

Finally, it is worth pointing out that these high-net-worth examples aren’t the whole picture. At the other end, equity release can have other consequences – on means-tested benefits, for example.

I love the idea of equity release. Assuming we don’t want to find a way to force them to free up family houses for actual families, it should, in theory, be the perfect solution for our house-rich, cash-poor retirees. But it isn’t.

There is now more flexibility in offerings than there used to be – you can’t end up owing more than the value of your house; some firms let you demand a guarantee that there will be some value left in the house for your heirs at the end; and some let you drawdown gradually to cut your interest costs.

But this remains a remarkably old-fashioned market – by which I mean very expensive, and far too opaque. (Look up “equity release calculator” online and you will find hundreds showing how much you can borrow, but none showing you the ultimate cost of that borrowing.)

I wrote a few weeks ago here about the opportunities for disruption in the wealth management market given our wealthy and ageing population. There are just as many here – despite the rise in regulation. But until someone picks them up (and I look forward to my first article on peer-to-peer equity release), anyone who wants to release cash from their house should just sell that house.

• I wrote last year about how one solution to the care problem might be some kind of state-backed equity release, whereby you could roll up debt at a low rate of interest and leave your local council to reclaim the cash from the sale of your house on your death.

This happens at some councils on a relatively informal basis, but its extension could be useful. This idea has been gaining some traction and a paper just out from Cass Business School and the International Longevity Centre expands on it nicely.

• A version of this article was first published in the Financial Times.


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