Congrats on making the vital steps towards a financially stress-free retirement!
However, if you’re not up to date with all the necessary mortgage terms, you could end up being taken advantage of by the so-called ‘experts’.
Fear not! We’ve got you covered.
We’re here to share:
- What a deferment rate is.
- Why it’s an important term to know.
- How it’s related to property valuation and equity release.
As leading experts in the later-life mortgage field, we’ve put together a dictionary of all the necessary financial terms and simplified them to help you release equity with ease.
Are you curious to learn about deferment rates?
Find out now!
What Is a Deferment Rate?
A deferment rate is linked to property valuation1. It’s the discounted rate that’s applied to your current property value in order to assess the present value of the right to vacant possession of your home when the lease2 expires.
The deferment rate is the most vital component in calculating the costs of lease extension.
*Vacant possession is a legal document covering all the terms of selling your property before it’s passed from one party to another.
The Background of Deferment Rates
When it comes to property ownership, the landlord owns a ‘reversion’.
This means that when a lease comes to an end, they’ve got exclusive rights over said property to then sell or rent.
If a lessee were to be enfranchised3, they’d have total possession of the house, and the landlord would use the reversion value.
There are 2 acts to ensure that the landlord is compensated for this loss in value:
- The Leasehold Reform Act 19674 is for houses.
- The Leasehold Reform, Housing and Urban Development Act of 19935 is for flats.
The compensation amount requires determining an estimated value of the deferred possession of the property.
In terms of renting, this will be the property value minus the loss of income or use during the lease period.
The total value of deferred possession comes from the deferment rate, or the rate of return that the homeowner would have received after management, void, and maintenance costs, during the lease period.
Owners would typically want a high deferment rate.
What Are the Types of Deferment Rate Methods?
The 2 types of deferment rate methods are the Sportelli Method and the Hedonic Regression Method.
Here’s more information:
- Sportelli Method – This is the most common method used by the Lands Tribunal, and for maths boffs, it is calculated as such: q = r* + P – g*
- Hedonic Regression Method – This alternative was proposed by Bracke et al. in October 2016. It’s based on collected market data for leases in the period of 1987 and 1991. Its goal is to isolate the effect of the value of an unexpired lease length through statistical analysis. The Upper Tribunal6 rejected this method in January 2018.
What’s This Got to Do With Equity Release?
Deferment rates are relevant with equity release, as the deferment rate sits at 1% annually for these products.
It’s used as an effective valuation tool to determine the total value of your estate, how much equity is in it, vs the value of your property when you pass away or move into permanent care.
The rate reflects the rate of return you’ll receive on the initial property price that’s agreed to. It’s used to determine the deferment price.
The deferment price differs from the forward price of the home in that the forward price is also agreed to at the beginning of the plan but is settled in the future.
These rates differ from the growth in market property value, which is usually 8% annually.
In Conclusion
While equity release can seem complicated, you’re not alone in the process.
Not only do you have excellent resources like ourselves to give you up-to-date knowledge, but you can also speak to a financial adviser who will be able to help you determine the best retirement moves for you and your family.
