It’s a common story. The property boom of the past few decades means that many Australians retire asset rich, but cash poor.
Yet many retirees are reluctant to downsize to unlock some of that real estate value. They might be attached to their home and rooted in the community, or it might be a financial calculation since the family home is currently exempt from the assets test for the age pension.
Could a reverse mortgage be the answer?
Borrowing a percentage of the value of your home can seem a painless way to access a lump sum or live a little more lavishly after you’ve downed tools. But is there a downside to the “spend now, repay later” set-up of augmenting your income stream or covering major expenses by tapping the family home?
Part-pensioner Peter Morris*, 68, doesn’t think so. He signed a reverse mortgage with Heartland Seniors Finance on his home of 40 years in Melbourne’s north east in June this year. The property, which is worth more than $2 million, comprises a 465 square metre house and a standalone, three-bedroom granny flat.
Morris borrowed about a fifth of the property’s value to clear a bank loan and substantial credit card debts accumulated in the years following his retirement in 2001.
He initially considered downsizing but was reluctant to sell and was concerned doing so would result in the loss of Centrelink entitlements, were he to bank the difference between the sum realised and the cost of a more modest replacement dwelling.
After reading about reverse mortgages, he decided to make inquiries.
“I had lots of worries about my finances … should I look for another job, what should I do … and this thing came up and looked like the best option for me, so that’s what I did,” Morris says.
He is about $1300 a month better off, having cleared his debts, and is open to increasing his loan balance to cover lifestyle spending, he says.
“Now this is an opportunity to do whatever we want – travel, renovate something in the house, renovate the kitchen … buy a new car, go overseas, whatever,” he says. “There’s all this freedom there to live a normal life like we used to live before. It’s great.”
Yet Morris is in a minority.
Although popular overseas, reverse mortgages remain a niche product in Australia, comprising just $2.8 billion of a total $1494 billion in residential lending to households, according to the Australian Prudential Regulation Authority’s latest data.
In March 2017, there were only 28,000 households with reverse mortgages, up from 20,000 in March 2018. But the average loan size has grown from $63,000 in 2008 to $100,000 now, in line with property values.
Financial comparison site Canstar lists just four institutions offering reverse mortgage products – Commonwealth Bank, Bank West, P&N Bank and Heartland, with the latter named pick of the litter in 2017.
Individuals may only borrow a percentage of the value of their homes – about 20 per cent for those in their 60s, rising to 30 per cent for those aged 70 and older. Loans are generally structured so interest can be repaid or added onto the loan. Principal and interest payments need not be made until a loan is terminated, which generally occurs after the home owner moves out, sells or dies.
Interest is typically about 2 percentage points higher than the market rate for a regular home loan and applicants are required to seek independent advice before taking out a reverse mortgage.
Homeowners of age pension age might also be able to access the Pension Loans Scheme, which is a government program designed to allow eligible retirees to supplement their incomes through a reverse equity mortgage. Payments are made fortnightly up to the maximum rate of pension and Centrelink charges 5.25 per cent compound interest on the outstanding loan balance.
Canstar financial services group executive Steve Mickenbecker says the reverse mortgage concept might have been tailor made for Baby Boomers. They’re retiring healthier and expecting to live longer and larger than their predecessors and a series of property booms during the past two decades have seen their homes soar in value.
Like Morris, typical customers are in their late 60s and early 70s, according to Mickenbecker.
“That’s the period where people are saying, ‘I think I can spend more money and there are things I still want to do and I just don’t have the cash to do it’,” he says.
But there are clear financial implications, as discussed at a recent Fairfax subscriber event on retirement.
“It’s tricky because you don’t repay anything when you’re alive and the debt rolls up and rolls up and rolls up so obviously it can erode the value of your house entirely, but it’s not supposed to be able to overtake the value of the house,” financial educator and Money columnist Nicole Pedersen-McKinnon told the audience in Melbourne.
Retirees could lose the bulk of their equity in the property if their loan is capitalised over many years and property values fail to grow apace with their spiralling debt.
At the same event, Grattan Institute chief executive John Daley recommended using a spreadsheet to model out the effect of the compound interest over time, especially if property values stay flat for a while.
“Compound interest is magic and the magic can work in reverse,” Daley says. “It’s worth modelling it out and saying how long does it last because it looks OK for five years and it kind of looks OK for 10 years but once it starts to fall off a cliff, it falls off a cliff really fast, If interest rates go up and house prices don’t go up, how much faster does that cliff approach. Go into it with your eyes very, very wide open.”
On the other hand, downsizing has financial risks too as they lose future capital gains on their property and might risk losing their age pension if the exercise leaves them with too much in the bank. And upsizing to a more expensive home to try to nab more age pension is risky too, since it’s likely the government will tighten the assets test further.
Mickenbecker warns tapping into home equity might mean you rob yourself of the ability to choose where you spend your final years.
Nursing homes and retirement villages often require a six-figure accommodation bond upon entry and some individuals who’ve eroded their equity might struggle to pony up.
“If you’ve got a modest house and not a lot of other assets, maybe it’s not the product for you because you might find yourself locked out of alternatives down the track,” Mickenbecker says.
Conversely, a reverse mortgage can be a good way to raise a nursing home bond quickly, according to CreationWealth adviser Andrew Zbik, who’s helped several families to do so.
“We might only take 20 or 30 per cent of the capital of the home and then lease out the home and the rent covers the interest payments on the reverse mortgage,” Zbik says.
“It’s a nice situation where the family hasn’t had to chip in in a hurry and we haven’t had to sell the home.”
He is less enthusiastic about the notion of using a reverse mortgage to finance new cars or holidays to Hawaii and says downsizing and investing the surplus often makes more sense financially.
“It’s like living off a credit card, if you’re doing it for pure lifestyle expense … I think the bank wins.”
Pensioners and part-pensioners should seek professional advice to ensure drawing a lump sum does not result in the loss of Centrelink entitlements.
Keeping family in the loop is also recommended since some offspring might be underwhelmed by the news that mum and dad have found a new way of spending their inheritance.
“You need to talk to family and say, ‘here’s what I’m doing, here’s why I’m doing it and it does mean something when I pass on in terms of released equity in the property’,” Mickenbecker says.
Money columnist Noel Whittaker, who also spoke at the Fairfax subscriber events, agrees that consulting with family is important, as there may be other options.
“If you’ve got a reverse mortgage that is effectively you spending money that you’re not leaving to your kids, I think the family should be involved … perhaps they could pay the interest, so the debt doesn’t go up,” Whittaker says.
* Name has been changed by request.
This article by Sylvia Pennington originally appeared in Sydney Morning Herald on the 14th July 2017. References to Andrew Zbik have been amended to mention CreationWealth