GILTs are government bonds, and their yields (or rates) fluctuate with the Government requiring more or less borrowing. But why might you have heard of GILT yields impacting equity release?
Long-term GILT yields can impact equity release rates and Early Repayment Charges (ERC). When GILT yields rise, equity release interest rates will also rise. As GILT yields fall, interest rates fall. However, plans with GILT-linked Early Repayment Charges follow an opposite pattern. When GILT yields rise, the ERC is low. When GILT yields fall, the ERC may be large.
GILT yields can be confusing, so in this guide, I will explain why and how GILT yields are linked to equity release interest rates and their Early Repayment Charges.
When I look at equity release interest rates, I find the most important GILT yield to track is the U.K. 15 Year GILT, as movements in equity release interest rates broadly follow the same movements.
You can track the movements in the U.K. 15 Year GILT here.
Historically, movements to the U.K. 15 Year GILT have broadly followed the interest rates offered for equity release.
During the COVID-19 pandemic, the U.K. 15 Year GILT was low, and we saw the lowest equity release interest rates in history.
Following the mini-budget in 2022, the GILT rate has risen, and equity release interest rates have also increased.
It is unlikely that equity release interest rates will fall to the low levels we saw before; instead, they have broadly normalised.
In this guide, you will learn:
There are two types of equity release; however, in this guide, I will focus on the most common type, lifetime mortgages.
The other type of equity release, a home reversion, will still be impacted by movements in GILT yields, but only in the amount of money they offer.
Equity release loans are long-term investments for equity release lenders. Long-term GILT investments are an altertive investment for the equity release funder. Therefore the interest rate on equity release plans are closely linked to long-term GILT yields.
Equity release lenders allow people to borrow money against their property at a fixed-for-life interest rate. The natural end of the plan is when the borrower passes away or moves into a care home, and the original amount borrowed, plus any interest, is repaid to the lender.
The equity release loans are illustrated over a minimum 15-year term; however, a younger borrower may expect their plan to run for 40 years.
Therefore, the money loaned is a long-term investment for the equity release lender.
However, these lenders also provide Government loans in the form of GILTs. These GILTs last for years, such as 15, and the Government repays the lender, plus interest.
These two options are the most preferred investments for equity release lenders, as most are insurance or pension providers. As you can imagine, these insurance and pension providers have significant funds available for investing, as payouts for insurance and pensions usually don't happen for many years.
The lenders invest the insurance and pension clients' payments into long-term investments. They have safely grown their investment at the end of the long-term investment.
If GILT yields are high, the lender prefers to invest their money into GILTs, as they will see a good return. Plus, GILTs offer the lender the highest level of security, as the Government is borrowing the funds, not an individual borrowing against their home.
Long-term GILT yields impact the interest rate and maximum loan amount the lenders offer to new clients. As we know, when GILTs are performing well, and yields rise, the lenders prefer investing in them rather than in equity release.
Therefore, when GILT yields are high, the lenders increase the interest rates on equity release plans for new customers. Otherwise, the GILTs will dramatically outperform equity release, and there would be little point for the lenders to offer equity release.
Early Repayment Charge (ERC)
When you initially take an equity release plan with a GILT-linked Early Repayment Charge, you will be assigned a certain GILT with a starting rate.
If the GILT yield rises above its starting rate, it performs well. Therefore, there will be no ERC if you wish to repay your equity release early. We will look at this in more detail later.
When GILT yields fall, it causes the direct opposite impact on equity release plans to when they rise.
When GILTs perform poorly, with low yields, the lenders prefer to invest in equity release rather than GILTs.
Therefore, when GILT yields are low, the lenders lower the interest rates on equity release plans for new customers. This, in turn, increases the number of new customers for equity release.
Early Repayment Charge (ERC)
When GILT yields fall from their original starting rate, they perform poorly.
Therefore, equity release plans with GILT-linked Early Repayment Charges would levy a larger ERC if you wished to repay the equity release early.
The lender wants to invest in equity release for as long as possible or have their money returned with an Early Repayment Charge linked to the performance of GILT yields, as this is where else they could invest their money instead to make up for it.
However, all equity release lenders offer plans with fixed known ERCs which is often the preferred choice.
Equity release interest rates are not directly linked to the Bank of England (BoE) Base Rate.
However, it is a common trend that when the base rate increases, interest rates across all borrowing increase, including equity release interest rates. This is to help fight inflation. When inflation is too high, the BoE increases the base rate.
This encourages people to save money in banks with higher interest rates rather than borrow money, such as using equity release.
Luckily for borrowers, almost all equity release plans offered are fixed-for-life interest rates, so you do not need to worry about interest rates increasing in the future after the plan is taken.
However, there are historical plans that offer variable interest rates. Again, these are not directly linked to the BoE base rate but are impacted by its movement.
Residential mortgage interest rates are linked much closer to the Bank of England base rate and swap rates.
Most residential mortgages in the UK are sold on a 2, 3, or 5-year fixed period. Therefore, their interest rates are much less linked to the long-term GILT yields. Subsequently, equity release interest rates do not necessarily follow the same short-term price movements as the mortgage market.
Just because you see news articles saying that mortgage interest rates are going up or down does not mean that equity release interest rates are doing the same.
Although rare nowadays, you can still get equity release plans with GILT-linked early repayment charges (ERCs).
When you initially take a GILT-linked equity release, you will be assigned a certain GILT with a starting rate. The lender will fully inform you of which GILT the lender assigns you and its rate.
- If the GILT yield rises above its starting rate, the GILT is performing well. Therefore, there will be no Early Repayment Charge (ERC) if you wish to repay your equity release early.
- If the GILT yields fall below the starting rate, the GILT is performing poorly. Therefore, if you wish to repay the equity release early, the ERC would be higher.
All of these plans have a maximum ERC that the lender can charge you, which will be shown in your equity release illustration and mortgage offer. The highest GILT-linked ERC is 25% of the amount you borrowed, offered from Aviva. However, other lenders, such as Just Retirement, have a cap of 20%.
The ERC is calculated on a sliding scale. The lower the GILT yield falls, the higher the ERC will be up to 25%.
Although you might have no ERC with GILT-linked plans, you have the risk of paying up to 25% extra to stop your plan early. As you can imagine, this puts many people off. But the good news is all lenders in the market now offer the option of fixed Early Repayment Charges with no change to the interest rate.
Commonly, a fixed structure will last 8, 10 or 15 years, and the ERC decreases as time goes on.
Example of a 15-year ERC structure:
- Year 1: 10%
- Year 2: 9%
- Year 3: 8%
- Year 4: 7%
- Year 5: 6%
- Year 6: 5%
- Year 7: 4%
- Year 8: 3%
- Year 9: 2%
- Year 10: 1%
- Year 11: 1%
- Year 12: 1%
- Year 13: 1%
- Year 14: 1%
- Year 15: 1%
- Year 16 onwards: 0%
As you can see, you know exactly what the ERC will be at any point in your plan, making them more preferred for planning purposes.
However, we cannot ignore GILT-linked ERC plans entirely. Yes, they are riskier, as the potential ERC can be higher, but if you believe GILT yields will perform well in the future, it may be your best option.
Although equity release advisors are qualified, we cannot indicate how GILTs will perform in the future.
If you have further questions, why not speak with one of our qualified advisors?
Call us on 0207 158 0881 or use our online form to book your FREE consultation.
While a qualified equity release advisor has written this guide, it is not intended to be used as financial nor legal advice and should not be relied upon.
To understand the full features and risks of an Equity Release plan, ask for a personalised illustration.
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