How to buy a mansion with your super and win

Reverse mortgages are a blessing for retirees wanting to tap their equity in the family home.
These people are mostly asset-rich, cash-poor baby boomers with little or no super. But in future the number of people using reverse mortgages might be swelled by retirees who have plenty of super, and who cash it in to buy a more expensive home which they then live off, putting their wealth outside the means test so they can qualify for the age pension.

A reverse mortgage allows you to draw a regular income from the equity in your home. In essence, the plan substitutes an income stream from an 'exempt’ asset (the mortgaged home) for income from an allocated pension, which is means tested. The consequent eligibility for the age pension is a big attraction: at about $400,000 for a couple, the present value of receiving the age pension for life far exceeds the tax likely to be payable when cashing-out superannuation assets.

Simply put, becoming eligible for the age pension may be a considerable encouragement to some deft asset manipulation, all within the rules.

It is an embryonic business in Australia, but reverse mortgages are reportedly growing quickly off a small base. The potential is huge: there are millions of emerging 'borrowers’ and their houses are generally worth more than $250,000 each.

It makes good sense for many retirees - especially those with no children, or perhaps rich children - to have access to some of the equity in their home without selling it outright, and continuing to live in it 'forever’ in retirement. Using these no-repayment, lifetime loans that are repayable only when the property is finally sold, retirees will be able to draw a regular income in the form of additional cash advances.

Lenders offering reverse mortgages have formed an association, the Senior Australians Equity Release Association of Lenders (Sequal), and have drafted an operating code that addresses concerns potential borrowers might have. In particular, the code precludes the possibility of borrowers being evicted, because the accumulating debt can never exceed the value of the home. The code also avoids the situation that arose recently, when some retirees were disadvantaged after the sale of their homes was separated from the contract to pay loan instalments.

Most people who are contemplating finishing work now have a passing familiarity with 'reverse mortgages’ as an innovative product able to release equity from their home in retirement.

Some regard it as a last resort because they had planned to pass on the family home to the children. But while bequeathing the home might be a cultural tradition, but it is not the only way for people to pass on their wealth. As people live longer, and families become more complex, resolving inheritances before people die could cut the potential for disputes and ensure that they really are the late lamented.

The pending retirement of baby boomers is likely to see reverse mortgages used more often to widen their lifestyle options after they finish work. There is much to be considered when, potentially, homes become DIY super funds: retirees will effectively be able to have their house and 'eat’ it too. Adding access to a full age pension because the home is not means tested brings a whole new dimension to retirement planning.

Using home equity as a super fund is comparable to drawing down an allocated pension from superannuation savings; it is actually more attractive because the 'income’ won’t be taxed and the 'asset’, being exempt from the means-test, will not prevent retirees receiving the age pension. All this changes the relative attractions of the choice between more housing and more super in retirement planning decisions.

Some retirees, with an eye to pension entitlement, will be less inclined to downsize their home and free up equity; others might see scope to retire earlier and run down assets that would be subject to the means test before they reach the age of 65.

A more aggressive strategy would see superannuation assets cashed out to buy a more expensive home which, in retirement, would return reverse-mortgage 'instalments’ to complement the entitlement to the age pension so contrived, while at the same time providing a rather nice lifestyle.

A hypothetical helps to make the point: In the model below a couple follow three scenarios (a) Buying a more expensive house, taking out a reverse mortgage and accessing the government pension. (b) Staying in their family home and taking out an allocated pension. (c) Selling their home, buying a less expensive house, and taking out an allocated pension.

The graph above shows the optimum potential of financing retirement through a reverse mortgage and drawing on government pensions. (Readers should note the model is not adjusted for inflation. Separately, readers should understand reverse mortgages only suit certain investors who are prepared live with a large mortgage in their later years.)

Legend - The model is based on a 65 year old couple who begin the exercise with combined assets of $300,000 equity in their home and $300,000 in superannuation.

The Blue Line - Assumes the couple sell their house, and spend $580,000 on a more expensive house take out a reverse mortgage and fully access government pensions.

The Red Line - Assumes the couple remain in their home and take out an allocated pension drawing minimum payments.

The Green Line - Assumes the couple sell ther house, spend $220,000 on a smaller house for and take out an allocated pension drawing minimum payments.

It is clear to see that in some instances taking out a reverse mortgage will clearly offer better returns. Which raises the question about whether the government will change the rules that allow a fast-growing aged population to draw the full pension and have a separate cash income by borrowing against their home. There are also implications for house price inflation if more retirees cash out their super to upgrade their homes.

Rules that encourage retirees to restructure their affairs to get the pension, and possibly bid up housing prices, seem perverse. But recasting the means test, perhaps to embrace the principal residence of retirees, is unlikely to be politically popular and will have to be weighed against increasing the tax burden on those still working.