Providing liquidity from illiquid assets
Equity release is a means of retaining use of a house or other asset which has capital value, while also obtaining a lump sum or a steady stream of income, using the value of the asset. It is also possible to make multiple withdrawals with equity release instead of just unlocking one big lump sum.
History of equity release in England.
First recorded use of equity release dates back to 1971. During the period between 1971 and 1991 there was no legislation regulating equity release. In 1992, a ruling under the "Equitable Life Assurance Society v Hyman" case ruled that the company's directors did not have unlimited power over pension investments. Later on, more legislations were passed, such as the Retirement Income Act of 2000 and Equity Release Council Regulations 2003, which set a debt cap for equity release loans.
Anyone offering advice on equity release or providing an equity release product is regulated by the Financial Conduct Authority (FCA), the UK's financial services regulator and watchdog. Equity release brokers, advisers and lenders are required to follow the FCA's strict rules and standards when providing information, advice or equity release products.
The Equity Release Council is the UK's equity release industry body that sets standards to protect consumers. Its members commit to following a set of five product standards: fixed or capped interest rates (for lifetime mortgages), the right to remain in the property, the right to move to another property, the ‘no negative equity guarantee’ and the right to make penalty free payments.
Types of equity release plan.
Two types of equity release product are available in the UK: a lifetime mortgage and a home reversion plan. A lifetime mortgage is a loan secured against the borrower's property where the borrower retains full ownership of their home. Interest accrues on a compound interest basis unless the borrower pays the interest in full each month. A home reversion plan is where a customer sells all or a proportion of their home at below market value and continues to live in the property as a rent-free tenant. With both types of product, repayment to the equity release provider is typically made through the sale of the property when the customer passes away or moves into long-term residential care.
Pricing of no negative equity guarantee.
The UK Prudential Regulation Authority expressed concerns in 2018 that firms investing in ERMs should 'properly reflect' the cost of the no-negative-equity guarantee. Its consultation paper CP 13/18, published 2 July 2018, provided a benchmark for valuing the guarantee. The paper recommended modelling the guarantee as a series of put options expiring at each period in which cash flows could mature, weighted by the probability of mortality, morbidity and pre-payment, using a version of the Black–Scholes pricing formula. It recommended that the underlying price of the option should reflect the cost of deferred possession of the property, independent of any assumptions about future property growth, warning that many of the approaches presented to it implicitly assumed negative deferment rates.
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