|Summary: For people in retirement with limited cash and a substantial asset in the form of the family home, tapping into this equity through a reverse mortgage facility is a definite option. But although the use of these facilities is on the rise, and safeguards have been put in place to protect the risk of negative equity, there are alternatives.|
|Key take-out: Those considering taking out a reverse mortgage should contact their financial adviser and Centrelink to ascertain how drawing out a lump sum could affect pension payments.|
|Key beneficiaries: General investors. Category: Investment strategy.|
The hunt for yield that will underpin any wider search for investment income can lead us in surprising directions.
Among the obvious areas, which should produce income, we can count shares, bonds and even cash deposits. Alternatively, if we find ourselves with a lot of ‘capital tied up in the home’, one avenue for creating a stream of income is a reverse mortgage.
Slowly, steadily, the reverse mortgage industry is taking shape: Though there are logistic and regulatory difficulties for promoters and customers alike, the conjunction of lower cash rates, rising house prices and an ageing population suggests nothing will stop reverse mortgages becoming a more popular choice for many investors.
This relatively new method of tapping income from the family home becomes even more relevant with mutterings about how sustainable the age pension is and hints of possible government moves to reduce access to the pension in the forthcoming May budget.
One particularly worrisome idea circulating at the moment is the possibility the government may include your principal place of residence to the age pension assets test (see Treasury hones attack on super).
If such a measure, or other variations of pension tightening, takes hold it may be that more people will have to consider a reverse mortgage or another strategy that allows them to use some of the wealth that they have built up in the family home to fund their retirement. It’s in that light I want to take a look at what’s on offer.
What is a reverse mortgage?
A reverse mortgage is a loan specifically tailored to a person in retirement who has significant equity built up in their own home. By using a reverse mortgage a person can borrow against their home to receive a lump sum or regular payments, with the interest being added to the loan over time.
When the home is sold – perhaps on the death of the homeowner – the loan and accrued interest is repaid.
The key element of the reverse mortgage is that it allows a retiree to use the equity in their home to fund living costs in retirement. Reverse mortgages that are currently available are based on a variable interest rate.
The risk of negative equity
A significant concern people have in considering the use of a reverse mortgage is that if they take out a reverse mortgage – particularly if they borrow early in their retirement – they could end up owing more than the value of their property after interest charges are added to the loan every year. In 2012 legislation was passed (the National Consumer Credit Protection Amendment Regulation 2012 (No. 3) that ensured “a borrower will not have to pay more than the market value of their home as repayment for a reverse mortgage (even if the amount of interest that has accrued would result in the balance of the debt exceeding that value)”.
Reverse mortgage products
There are various elements of a reverse mortgage that a borrower needs to understand. Chief amongst these is the amount of money that you can borrow, and the interest rate charged.
While traditional mortgages allow people to borrow sums of money almost equal to the value of the property (or even more that the value of the property), a reverse mortgage only allows much smaller levels of borrowing because no loan repayments are being made and interest is accruing in the loan.
For someone aged 65, they might be able to borrow 15% to 20% of the value of their property. For example, St George has a reverse mortgage that has a youngest lending age of 63, and allows people up to the age of 69 to borrow the lesser of $150,000 or 15% of the value of the home. Up to the age of 79 the borrowing is limited to the lesser of $200,000, or 20% of the value of the home, and beyond this the limit is $250,000, or 25% of the home value.
According to website Infochoice, current reverse mortgage rates range from 6.78% to 7.56%. This is significantly higher than standard variable rate loans. As another example, a provider offering a 7.18% reverse mortgage was, at exactly the same time, offering their standard variable rate loan at 5.99%, with discounted variable rates advertised as low as 4.99%. Put simply - the interest paid on reverse mortgages is high.
|Lender||Product Name||Compound Interest Rate %|
|Australian Seniors Finance||Lifetime Loan||7.24|
|BankSA||Seniors Access Home Loan||7.54|
|BankWest||Bankwest Seniors Equity Release Home Loan||6.78|
|Commonwealth Bank||Equity Unlock for Seniors||7.16|
|P&N Bank||Easy Living Access Loan||6.83|
|St George||Senior Access Home Loan||7.56|
|St George||Senior Access Plus Home Loan||7.56|
|Transcomm Credit Union||Annuity Plus Options||7.07|
|Transcomm Credit Union||Annuity Plus||7.07|
On the wrong side of compound interest
Compound interest is touted as many things – even the “eighth wonder of the modern world” according to Albert Einstein. Crucially, it is always much better to be receiving compound interest as a result of your investments, rather than paying it.
Using a reverse mortgage puts you right in the crosshairs of paying compound interest – you are paying interest on the interest that has been added to the loan.
Moneysmart.gov.au has a reverse mortgage calculator that shows a $100,000 loan borrowed at the interest rate of 7.56% for someone at age 65 becomes $437,000 by age 85 because of the interest accrued over time.
If you are considering a reverse mortgage you should discuss this with Centrelink to assess how it might impact any payments you receive or plan to receive. For example, if you were to take a large lump sum from a reverse mortgage, say $100,000, then you would need to understand how this increased amount in your financial assets (the $100,000 of value in your principal place of residence is asset test exempt, whereas a $100,000 deposit is a financial asset) affects your benefits or payments.
Issues from a personal finance perspective
As discussed, a reverse mortgage is a relatively expensive loan that will have interest compounding over time. A better alternative, if it is available, might be to look to set up a modest traditional loan, incorporating a line of credit, that you can use to withdraw some funds over time.
A strategy that looks to use modest amounts of money (say 1% of the value of a property per year) withdrawn through a loan secured by a property might be a way of accessing some of the value of a property in retirement. The later you start drawing funds, and the smaller the amounts withdrawn, the lesser the effects of compounding interest.
With house prices at record levels, uncertainty over the long-term funding of the age pension and life expectancy rates longer than ever, the idea of someone in retirement using part of the value in their home to support their cost of living is a reasonable one.
But it may well be that rather than using a reverse mortgage to achieve this, a more traditional home loan with a redraw facility might provide a similar way of accessing money at a lower cost.
Scott Francis is a personal finance commentator, and previously worked as an independent financial advisor.