Regulatory developments continue to be supportive with Retirement Interest Only (RIO) mortgages now carved out as a standard product
Two months after a FCA rule change carved out the definition of Retirement Interest-Only (RIO) from other lifetime equity release mortgages, expectations remain for high interest for the product. So far the majority of products on the market are classic lifetime mortgages, with interest rolling-up into the principal, although there is increasing flexibility on optional interest or principal payments.
Currently, providers of lifetime products featuring optional interest repayments include Hodge Lifetime, Just, L&G, OneFamily and Retirement Advantage. Other lenders including Aviva, LV=, Pure Retirement and more2life only have roll-up mortgages, although some capital repayment is allowed. However these products will require customers to receive regulated advice, as have all equity release mortgages in the UK since 2005, unlike RIOs.
The key regulatory development for RIOs is a change to the affordability rules, which now accept later-life borrowers who can service these interest-payable equity-release mortgages, making it a standard product not requiring financial advice unless other circumstances apply. This is especially relevant to existing conventional interest-only (IO) mortgage holders who have not succeeded with a plan for repaying capital at maturity and may struggle to find a new IO mortgage, facing steeper monthly payments. The popularity of IO mortgages and the first of Bank of England Base Rate rise in November (despite holds in Feb, Mar and May) means affordability will remain a focus for consumers and the fixed interest rate for life of a RIO should garner strong headline attention.
Growth in the RIOs is expected to exacerbate pricing dynamics in the broader equity-release markets, where competition between specialist providers has driven down rates as the market has expanded rapidly over the past few years. In 2017, the market reached £3.06bn, a growth of 42% over the year in a trend that has continued since 2011, when the market stood at £789mn. Whilst interest rates remain higher than conventional mortgages, the forthcoming quarter will be key to see how these growth and pricing dynamics evolve as new RIOs enter the market.
The secondary market for equity release mortgages has been relatively quiet in recent years, although there have been some bilateral / private portfolio sales, and public securitisations are very sparse. Most of the originators are now natural holders or partnered with such: Life Insurance companies are attracted to the duration, yield and longevity characteristics and can additionally achieve Matching Adjustment (MA) for annuity liabilities under Solvency II.
The attractiveness to these assets to Life Insurers continues to be a key area of interest for regulators. The PRA’s supervisory statement published last July (SS3/17) followed a review period of nearly two years and recognised the attractiveness of these assets for MA, whilst cautioning on the increased exposure to the residential property market caused by the No Negative Equity Guarantee. To be used for MA the assets need to be restructured via an internal securitisation such that they are bond-like, with fixed cash flows. Consultancy paper CP21/17 which closed at the end of January 2018 highlighted that firms should consider whether equity release mortgages with higher LTVs or younger borrowers may be more akin to a property investment. There additionally remains some debate in the market as to whether these mortgages, currently marked-to-model as a fair value asset, should really be considered as an insurance contract.
Rising life expectancy, housing supply shortage and stamp duty dissuading downsizing are all known issues affecting the residential UK property market. So the middle generation are getting cash calls from both sides: to help their Millennial children with a deposit to get them on the housing ladder, plus the potential for substantial care costs for their own parents. Hence the renewed focus on equity release mortgages over the past few years, where retired homeowners can afford the lifestyle they seek, undertake home improvements, help out the grandchildren or simply get their finances in better order, without the catch-22 of downsizing.
Equity release schemes are historically split into two types, both targeted for later-life homeowners (typically 55+ years) and guarantee customers can stay in their home rent-free until death or move to a care home, when the property will be sold:
Historically the lifetime mortgage market has been more popular than the home reversion market and the recent changes in regulation for RIOs are set to take that dynamic one step further. One of the key drivers behind the recent renaissance of the lifetime market is the move to substantially more customer-friendly features of many products: