Is a Reverse Equity Mortgage for You?
Once upon a time, two starving waifs lost in the woods stumbled upon a fantastic sight- an edible gingerbread house.
Yes, it’s a made-up story for children, but you too can eat your own home.
The product that makes it all possible is called a reverse equity mortgage. The idea is, you draw down cash against the value of your house, with not a penny payable until you sell up or die.
It was a ”great famine across the land” that sent Hansel and Gretel wandering in the first place; perhaps ye-olde Germanic equivalent of our own rather glum economic situation.
The low-interest environment means investment returns may not be enough to top up superannuation, leaving the home itself the only nest egg for some retirees.
”When they have no other means of accessing cash, our senior customers are telling us they want the ability to release some of the equity in their home rather than trading down or lowering their standard of living,” says ASB’s general manager of retail products and strategy Shaun Drylie.
If you’re over a certain age, usually 60-65, and own most or all of your own home, you can draw down a percentage of its value as a lump sum or in instalments.
”The older you are, the more you can borrow,” says SBS Bank’s Invercargill branch manager Neil Bramley.
At SBS for example, you can borrow up to 10 per cent at age 60, and 15 per cent once you hit 65. From then on, it’s one extra per cent for each year thereafter, maxing out at 50 per cent for venerable centenarians (Bramley: ”We’ve done a couple!”).
The interest adds on to the loan account each year, with no requirement to make repayments while you still live in the house.
Members of the industry body SHERPA (Safe Home Equity Release Plans Association) and the non-member banks promise that even if you nibble your house down past the foundations, a) they won’t kick you out, and b) they will carry the loss.
All in all, it sounds like a fairy-tale arrangement.
But the Brothers Grimm story would be incomplete without the sinister presence of the cannibalistic hag. An uncharitable comparison, perhaps, but the lenders have to get their pound of flesh.
1.Interest rate. The lenders we surveyed ranged between 6.6 and 7.7 per cent, 1-2 per cent higher than the standard floating mortgage rate to account for longer-term funding costs.
2.High fees. ASB’s products, for example, costs $850. Then there’s $500 for a registered valuation and legal expenses, which are typically around $1000.
3.Compounding interest. With no repayments to keep interest at bay, even a modest $40,000 loan will have snowballed into $77,000 in a decade, or $150,000 in 20 years.
1.Very few reverse mortgages are fixed, so there’s no break fee or disincentive for paying the loan back early.
2.Rising property prices can partially offset the cost of accumulating interest.
3.Cash is freed up for people who might otherwise be unable to access it.
”If this product is well-placed and transparent, it can be very useful to some people,” says Retirement Commissioner Diana Crossan. ”But it’s only a small group.”
It’s a niche product, after all. SHERPA figures show the market was worth just under half a billion in 2010, a tiny fraction of the $165 billion in residential mortgages at the time.
”The perfect person for a reverse mortgage- because it’s certainly not for everybody- is a little later in age, in their 70s and intends to stay in their own home,” says Vaughan Underwood, chief executive of reverse mortgage specialists Sentinel.
The industry gets a tick for ensuring that most are in the right demographic, with the average age of new borrowers 72 in 2010.
But that doesn’t mean everyone should live their golden years out with an equally golden high-roller lifestyle.
”We absolutely discourage anything that’s frivolous,” says Underwood.
The SHERPA stats for 2010 indicate most house-proud retirees are using the loans for more sensible purposes.
Twenty-seven per cent needed the cash for home improvement: property repairs and maintenance. In that respect, they’re probably winning, says Crossan. Maintaining their last major asset means they’re effectively investing in it.
The next most popular use was debt repayment, at 17 per cent. SHERPA executive director Rob Dowler says that would be either paying off the last of an existing mortgage, or getting rid of high interest-bearing debt.
From there, 15 per cent went toward travel, 10 per cent to cars, 8 per cent to aged care and the remainder unassigned.
Where people go wrong, says Dowler, is when their money ends up where it shouldn’t. Borrowing to invest has caused a few horror stories, he warns, as has funding a family member’s business venture.
Once you’ve been eating away at your equity for a decade or two, your children may end up with rather scanty crumbs to squabble over.
”It is a risk that family members may feel aggrieved that what they perceive to be their inheritance has been whittled away”, says Dowler.
It’s really important to talk to your family, Crossan advises- perhaps they’ll even front up the cash: ”That has led to family saying, ‘Goodness me! I’ll buy it off you, mum.”’
Of course, Dowler points out that at the end of the day the house belongs to the individual or couple. ”It is their right to make their own decision.”
For those who are cash poor and asset rich but don’t like gingerbread, there are plenty of less sticky alternatives on offer.
Crossan suggests considering renting part of your home, taking in a boarder, moving to a cheaper house, sub-dividing or selling to family.
To their credit, all the lenders make it clear that an alternative might be more suitable. ASB, for example, takes clients through three meetings to ensure the loan is right for them.
”We’ve also guided several customers through the three-stage application process and they have ultimately decided on alternative financial options”, says Drylie.
SBS’ Bramley says the bank offers a range of products, and tries to help customers find the most suitable one.
In that respect, the banks are probably better than the specialist reverse mortgage companies. But the banks are also more or less your only option, for now:
The global financial crisis all but squashed the reverse mortgage market flat.
Lack of accessibility to funding curtailed everybody’s loans, said Underwood, particularly in the longer term.
Sentinel is the only one of the three reverse mortgage-specific firms still taking on new loans, and even then it has reduced to a trickle.
Nevertheless, the spiderwebs may be brushed off the loan books soon. Credit markets will never return to where they were pre-GFC, says Underwood, but they will improve.
And the banks don’t even have that problem, with ASB, TSB and SBS all open for business. ”There’s no difficulty with funding,” says Bramley. ”If we saw an increase in this type of business that would be fine.”
But as he says, they’re not exactly shouting it from the rooftops. Things may pick up once the specialists -who tend to advertise more aggressively- are back in the market.
”With people basically cash-strapped and asset rich, this type of facility could come back in vogue”, says TSB’s manager of lending services Phil Gerrard.
”People in that sector [65+], obviously their income stream is not what it has been- generally not at the same level. As time goes by, and with the cost of living increasing, there could be a resurgence in that sector.”
Dowler reckons any increase will be driven by the aging population and the damage to wealth levels caused by the GFC.
Clearly we haven’t seen the last of reverse mortgages yet. The decision has big consequences, so it pays to remember that you can’t have your cake and eat it too.
– (Live Matches)