For the asset-rich, cash-poor retirees who were too late into the superannuation system to build a decent balance, reverse mortgages seem the ideal product. Banks will lend between 15% and 35% (rising with age) of the value of residential property as a lump sum or income stream, and it may give a standard of living the age pension struggles to deliver. There’s no need to make loan repayments as the bank recovers the debt from the estate.
When Nobel laureate Robert Merton visited Australia in late 2014 to talk about retirement incomes, he argued the family home is no longer the treasure that must be passed on to future generations. “In retirement, it’s a financial asset,” he said as he pushed the potential of reverse mortgages in retirement plans.
So why have loan volumes been falling, with less than 40,000 reverse mortgages in Australia? The total market is only $3.6 billion, the average loan size is about $85,000 and the average age of the borrowers is 75.
A real-life example
My friend Susan (not her real name) was the perfect candidate and recently took out a reverse mortgage. Her house was almost paid off, but over her working life, she had not accumulated much additional savings. The single age pension per fortnight is $860. With a car and house to run, $60 a day does not go far. In retirement, she struggled to live the lifestyle she wanted, while her house was rapidly increasing in value. “I realised the only way I could get out of my financial problems without selling my home was a reverse mortgage.”
After reading as much as possible online, Susan went to see a financial adviser, who had never arranged a reverse mortgage. The broker he referred her to also had no experience. Eventually, she found a broker who negotiated a loan with BankWest. Many banks do not even provide the product, ANZ and Bank of Queensland the latest to drop it.
When Susan first went to draw some income, the branch staff told her she needed to withdraw the lump sum. This was unacceptable because having the residual cash in her bank account would affect her age pension entitlement. She had to convince them she only wanted money as she spent it.
Reasons for the product’s lack of popularity
What are other reasons for the product’s stigma, when the providers don’t educate their staff and the public perception is not favourable?
The interest rate is about 1.5% higher than the normal home loan rate, currently about 6.5%, meaning the debt doubles in about 11 years. This is why the maximum loan is set at only 15% of the property value for someone aged 55 – they may live another 40 years!
Lenders are concerned about behavioural issues such as cognitive decline, especially given the ages of many of the borrowers.
Heirs to the estate see their asset being whittled away by interest and fees, and lenders worry about their rights being challenged. One banker told me this is the most significant risk in offering the product. The bank could be taken to court by the children claiming their ageing parents did not understand what they were doing.
Over 90% of loans are variable rate, exposing the borrower to rising rates. Fixed rates would need to include break costs.
With compounding, the debt will rise quicker than borrowers expect.
The Australian Securities & Investments Commission (ASIC) provides a reverse mortgage calculator on its MoneySmart consumer website. All lenders must use it to show prospective borrowers a range of outcomes.
ASIC even requires the lender to enquire about the consumer’s requirements and objectives, including the future need for aged care accommodation and consequences for reductions in the estate value. Susan does not recall this happening.
There are official guidelines on loan to valuation (LVR) ratios, stating that if a borrower is 60, an LVR over 20% is unsuitable unless the contrary is proved. Under rules legislated in 2013, the lender must also give a ‘no negative equity’ guarantee.
What is the money being used for? The top five uses are home improvements, debt repayments, regular income, travel and buying a car.
While every borrower needs to understand the risks, reverse mortgages may be an alternative to struggling through retirement after a lifetime of work and sacrifice.
Graham Hand is Editor of Cuffelinks. This article is for general educational purposes and anyone considering acting on the information should first consult a professional adviser.
Reader, John Witham, sent in the following suggestion after this article first appeared in The Australian. It’s a proposal aimed at assisting older Australians to access the equity in their homes to fund retirement. We welcome any feedback in the comments section.
Proposal
That the government introduces a National Equity Access Scheme for Older Australians who own their own homes.
Background
Many older Australians who have retired or who are approaching retirement own their own homes but have insufficient income to enjoy what they would consider to be a comfortable retirement.
Several banks offer ‘Reverse Mortgages’, which allow participants to obtain funds of up to a certain percentage of the value of their property and not make any repayments until the owner(s) die or sell the property.
The costs of taking out such a mortgage are significant and include: valuation fees, administration charges and stamp duty. The interest costs are also around 1.5% higher than those charged on a mortgage for a new home buyer.
Reverse mortgages are not broadly popular and it is quite possible that entering into such a mortgage is seen as a last resort to maintain solvency and, as such, may carry some form of stigma. While some potential beneficiaries may encourage their parents or other older relatives to take out a reverse mortgage because it will improve their living standards, others may discourage them from doing so because it will diminish their inheritance.
Australia has an ageing population and a large proportion of home owners reaching retirement age have insufficient superannuation to maintain a lifestyle similar to that which they had while they were working, despite no longer having to pay a mortgage. In such circumstances they tend to live relatively frugal lives and minimise their outgoings. As a group they are increasingly depicted as a financial drag on the economy.
The National Equity Access Scheme for Older Australians
The proposed scheme includes the following features:
Participants must have reached the age of retirement and must own their own home
Participants will be provided with a line of credit equal to 4% of the value of their home upon joining the scheme
A further 4% will be provided in each successive year and unused credit may be carried forward to future years
It will be sponsored and guaranteed by the commonwealth government and administered through selected banks
There will be no administrative fees
Valuations will be taken to be the Capital Valuation used for setting council rates
Stamp duty will be not be payable
Maximum interest rates will be set by the government at a rate equal to the most favourable rates available to new home owners
Regardless of how long the participants live the debt incurred will never exceed the current value of their home
Benefits of the scheme
The Scheme would enable participants to draw down an amount equivalent to 4% of the value of their home every year to supplement their ordinary income whether that be superannuation, a pension or both. A person or persons owning a home with a value of $500,000, would be able to supplement their income by $20,000 per year. For a couple on the age pension this would provide a major boost in terms of their standard of living.
Those who have some superannuation, may not need to draw down funds from the Scheme for several years. However, if they enter the Scheme upon retirement, their line of credit will build each year. For example a person who enters the Scheme at age 65 but does not draw down funds until the age of 70, will be able to access up to 20% of the value of the property at that time. This flexibility would help older house owners to afford necessary maintenance and upgrades to their homes, the replacement of major household appliances and the purchase of consumer goods.
It is probable that persons entering the Scheme will be less likely to require government assistance. For example they might decide that they can afford to continue with their private health fund coverage.
A major benefit of the Scheme is that it would transform potentially hundreds of thousands of older Australians from a perceived burden on the economy to a very significant consumer group. This would provide a significant boost to the economy as participants spend funds that would otherwise be retained in their properties to be spent by their beneficiaries 15-20 years into the future.
While the Scheme would certainly improve the living standards of the participants, reduce demands for government services and provide a boost to the economy, the most important benefit could be changes to the general perception of older people.
Older Australians will need to be convinced that it is not only sensible and safe to enter into the Scheme and that it is their right to spend some of the money that they have invested in their house over the years to maintain a reasonable lifestyle.
The proposed scheme would not be expensive to implement; the major outlay would most likely be the cost of promoting it. The participating banks would gain a very significant increase in business.