Retirement option gets a makeover

Consumers will have more protection when they take out a reverse mortgage, writes John Kavanagh.

Consumers will have more protection when they take out a reverse mortgage, writes John Kavanagh.

Lenders selling reverse mortgages must give consumers more comprehensive disclosure documents, under new provisions of the consumer credit law that were passed in the House of Representatives last month. Lenders will also have to remove unreasonable categories of default from their contracts and give a no-negative-equity guarantee.

These changes may prompt retirees to take another look at reverse mortgages as a way of generating additional income in retirement. After growing strongly in the middle of the past decade, the product has fallen out of favour in recent years.

Hardly a month goes by without the release of a new research report showing that baby boomers are worried they have not saved enough to live on in retirement.

Reverse mortgages are a legitimate, if risky, part of the retirement planning tool kit.

A reverse mortgage allows a retiree to use the equity in their home to raise funds. There is no requirement for any repayment until the borrower sells the house, moves into an aged-care facility or dies.

The advantage is that you are able to draw on the equity in your home and have money to live on, without having to sell the family home.

But there are disadvantages.

The risks

The interest you would normally pay back each month is capitalised and the value of the loan grows over time. You start out with a relatively modest loan and end up with a big one. Offsetting this is the likelihood the house's value also increases.

What makes this a risky proposition is that you don't know how long you will live, how much interest rates will change or how the value of the house will change.

You can calculate the likely final value of the debt based on your life expectancy but you might live longer - and then you will owe more.

Most reverse-mortgage contracts allow a surviving partner to continue living in the house, so you need to think about your spouse's life expectancy as well as your own.

Another potential risk is the impact money received through a reverse mortgage will have on Centrelink benefits. If the borrower takes a lump sum and invests it, distributions from the investment will increase "deemed income" and lead to reduced pension payments.

If the lump sum is held in a bank account, Centrelink allows a grace period of 90 days and then counts the balance towards the asset test.

If the money is taken in periodic payments and spent soon after, it is not accountable for Centrelink purposes.

New rules

The new rules governing reverse mortgages are part of an amendment to the National Consumer Credit Protection Act.

The new law introduces a statutory protection against negative equity, which means that the money owed on a reverse mortgage can never be more than the value of the mortgaged property.

The new law also beefs up reverse-mortgage lenders' disclosure requirements. Lenders must take borrowers through a projection of the loan outcome using a website approved by the Australian Securities and Investments Commission. Lenders must also spell out how non-title-holding residents will be treated under the reverse-mortgage contract.

Lenders cannot complete a loan until the consumer has received legal advice regarding the contract.

The new law also bans certain categories of default, which have been used in the past to commence enforcement proceedings because of minor oversights. These include failing to inform the lender that someone else lives in the property, leaving it unoccupied or failing to pay rates or insurance costs.

The Canstar website lists eight reverse-mortgage lenders. They are Australian Seniors Finance, Bank of Melbourne, BankSA, Bankwest, Commonwealth Bank, Police & Nurses Mutual Bank, St George Bank and Transcomm Credit Union.

Interest rates range from 7.39 per cent (Transcomm) to 7.95 per cent (Commonwealth Bank).

Canstar's research manager, Chris Groth, says that when his team produced its first research report on the reverse-mortgage market in 2008 there were 14 lenders active in the market. The reduction in that number reflects weak demand in recent years.

Borrowers should also consider the Pension Loan Scheme offered by Centrelink and the Department of Veterans' Affairs. Borrowers need to be of Age Pension age and either not be receiving the Age Pension or receiving only a part pension.

The scheme pays an amount each fortnight up to the full Age Pension rate. As with a reverse mortgage, real estate is required as security and the interest (current rate 5.25 per cent) compounds during the loan's term.

Survey results

According to the latest Deloitte and Senior Australians Equity Release Association (SEQUAL) survey, reverse-mortgage lenders settled $317 million of loans in 2011 - a fall of 1.5 per cent from 2010. The market has recovered from its slump in 2009, when settlements fell to $264 million, but it is still well short of its peak year, 2006, when settlements hit $520 million.

The 5000 people who took out reverse mortgages last year borrowed an average of $63,600. Their average age was 75. A banking partner at Deloitte, James Hickey, says the most common reason for taking out a reverse mortgage is to pay for home improvements. Other common uses are to repay other loans and for regular income.

The popular image of reverse mortgages is that once you have got one its stays with you until you sell your house or die.

However, the Deloitte/SEQUAL survey shows about one-fifth of the discharges were mandatory (due to death of the borrower or entry into an aged care facility), about one-third were voluntary repayments, one-third were a result of property sales and the balance were a result of refinancing.

What these figures suggest is that a significant number of people who enter into a reverse mortgage are able to manage their way out it is not a one-way street.

The National Information Centre on Retirement Investments has a government-funded helpline for consumers. Phone 1800 615 676.

Calculating the outcome

What makes a reverse mortgage different is that you don't pay the money back until you sell your house or you die (and the house is sold by the estate).

The Australian Securities and Investments Commission's MoneySmart website has a reverse mortgage calculator, where you can create different scenarios. Here is an example:

Say you retire at 65 and by the time you reach 70 the retirement savings are starting to run a bit low. Your house is worth $1 million and you decide to take out a reverse mortgage to release $80,000 of the equity in your home.

You draw down $50,000 immediately for home repairs and to replace your car. Then you draw down the balance in $500 monthly payments over five years. The rate on the loan is a constant 7.5 per cent.

Fifty per cent of men aged 70 can expect to live another 15 years. By that time the outstanding debt will be a little less than $239,000.

If your house increases in value by 5 per cent a year, it will be worth $2,078,000 after 15 years. Once you (or your estate) have repaid the loan, there will be about $1.8 million of equity remaining.

If you are among the 5 per cent of 70-year-old men who live to 95, the loan value will grow to more than $600,000. If there was no growth in the capital value of the house, you (or your estate) would be left with equity of less than $400,000.

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