This is an article from The Equity Release Council that one of our Directors, Paul Saroya was invited to contribute to as an expert in this sector.
When Retirement Interest Only Mortgages (RIOs) were launched in 2018 to great fanfare, they promised to be the answer to the plight of many older homeowners who were unable to repay interest only mortgages. But adoption since then has been extremely low. So what is to become of the RIO? Was it a well-meant experiment that should be allowed to wither and die, or are the current range of RIOs merely the first wave which — with a bit of tweaking — can evolve into a crucial mainstay of the retirement mortgage market?
We asked some of today’s retirement mortgage advisers what was wrong with RIOs and some common themes quickly emerged. The first comes down to cost. There was an overwhelming sense that RIOs were too similar to lifetime mortgages and couldn’t compete with them.
There is something counterintuitive about the way they are priced, says Lisa Ridley, director of Green Pea Mortgages. Lisa points out that, despite them being underwritten in a way that is similar to lifetime mortgages, the consumer is the victim of a higher rate at the outset, tougher affordability criteria, and no certainty of interest rate beyond the mortgage term.
“RIOs are too expensive and too inflexible,” she says. “Set up costs and interest rates need to be reduced. If a five-year fixed rate is right, why should this be more expensive than a standard residential mortgage? The risk is underwritten at the outset, with affordability assessed jointly and individually.”
It’s a problem also identified by David Wright, MD of Sixty Plus, who says that “lifetime mortgages can offer a similar or lower rate but fixed for life”. When they were introduced, RIOs were billed as a stepping-stone into later life for borrowers who had interest only mortgages. The FCA had grown concerned that many homeowners with interest-only arrangements were unable to pay off the capital sum at the end of their mortgage term without selling their homes. In March 2018, the regulator moved to relax rules, opening the way for RIOs to solve this problem.
They got off to a very slow start with only 112 sold throughout that year. Their use has increased, but on nothing like the scale of other products. RIOs have been criticised for only being accessible to a small minority of borrowers because the affordability criteria are too similar to a conventional mortgage. This is despite the fact that borrowers using RIOs — which are typically only available to those aged over-55 — only have to demonstrate they can afford the monthly interest payments. This is one of the key differences with many lifetime mortgages. Interest on RIOs is paid off monthly so it doesn’t roll up and eat into equity. Borrowers don’t need to have a long-term plan to pay off the loan either. It is simply repaid when the homeowner dies or goes into long-term Care.
Even so, it is the long shadow of a far greater number of well-established and competitive lifetime mortgages that prevent more widespread use of RIOs, according to Ryan Mansell, director of Later Years Financial Solutions. “I do not believe that they are unpopular, but rather they are the victim of lifetime mortgage product innovation making them hard to look beyond.” It’s a view echoed by Lisa: “Innovation and flexibility within the Equity Release market means that these outshine the RIO.”
Ryan cites higher LTVs, particularly in the 55-65 age bracket, as one of the key benefits of RIOs but stresses that consumers often want longer term certainty. That means they often opt for the more predictable interest rates offered by equity release, over the uncertainty of RIOs that offer fixed interest rates for a limited time. In that context, high set-up costs for RIOs make them seem even less worthwhile. “Their timing of coming to market was unfortunate,” adds Ryan. “I believe, if lifetime mortgage rates were still 4.5%+, there would be more applications across the industry. There is a lot of uncertainty about what could happen in the future with many clients opting for the peace of mind of lifetime fixed rates.”
So do RIOs have a future or are they destined to fade away? If they are to break through as a mainstream stepping stone into retirement, then there’s no doubt that RIOs need to evolve. The question is, can they evolve and do they have a future?
Paul Saroya, Director of Viva Retirement Solutions, is in no doubt. “There is definitely a market for RIOs and they should be improved to help people who, in reality, sit in between a conventional mortgage and a full-on lifetime mortgage.”
Younger retirees who cannot borrow enough using lifetime mortgages would benefit from RIOs that worked harder for them. RIOs are billed as long-term products but, according to some, this is undermined by their interest rate structure which is either variable or fixed for between two and five years.
Beyond reducing set-up costs and interest rates — a view shared by Ryan — Lisa thinks RIO rates should be fixed for the long term to overcome this problem. Interest rates are also currently very low and she also has one eye on inflation rising in the future. “Interest rates need to be fixed for the long term. Otherwise, this could lead to arrears and possible repossessions, in the event of interest rate rises; the impact of which would be very damaging to the industry,” she says.
The potential for a hybrid product to be created appears to be extremely popular.
“Why can’t a client get a RIO where, on failing a stress test, a lifetime mortgage could replace it?” Paul asks. “I think that both types of plans could work hand in hand more, rather than against each other. In many cases the RIO may be a stepping-stone towards a lifetime mortgage.”
Lisa agrees. “If they are to be used as a long term solution there needs to be more flexibility built into RIOs, so that they can evolve over the term of the mortgage to reflect the changing needs over the borrowers lifetime. “[In other words] having the ability to convert some or all of the mortgage to traditional interest roll up.”
Ryan suggests this switch to rolled up interest could happen when a borrower hits 75. “This way, if affordability issues arrive, the clients have the option to stay in their home. Adding in flexible payments if this happens would be the perfect scenario.”
Other suggestions include ‘realignment’ of affordability and stress tests, and standardisation among lenders when it comes to what counts as income to improve access. These are just some of the areas advisers think that providers should explore. There’s plenty of scope for improvement so it looks unlikely that RIOs are going to wither and die.
It may, though, come to pass that RIOs split into two distinct variations to satisfy different types of consumer because some customers want a short-term, not a long-term, solution. “It’s hard to see how corners can, or should, be cut,” says David Wright. “But I don’t think [RIOs] will fade away. For people with shorter term needs who don’t want to be tied into a lifetime mortgage, or for higher LTVs, RIOs have a place.”
The views of contributors are not necessarily those of the Council.