The growing number of previously self-funded retirees who now get a part pension would lose it if the government adopted hardline reforms that included the family home in its means test. Of course, no such policy yet exists but a number of submissions to the national tax review argued it would be a sensible way to address the financial strain generated by an ageing population.
The submissions are a clear sign that the status of the family home as a sacred cow can no longer be taken for granted, and are part of a groundswell of opinion that older workers should take greater responsibility for their retirement.
The over-60s hold at least 40 per cent of the total home equity of Australians and some lobbyists consider it fair enough that retirees should be forced to use their equity to fund retirement, rather than rely on other taxpayers for support.
Such suggestions, coupled with investment losses suffered in the bear stockmarket, could cause a surge of interest in equity-release schemes such as reverse mortgages. They are readily available from 10 or so lenders who have survived the credit crunch. But reverse mortgages need to be used cautiously, especially in a period of falling property prices and potentially rising interest rates.
A reverse mortgage allows someone over age 60 to borrow money against the equity they hold in their home.
No principal or interest is repaid until the home is sold or the borrower dies or permanently vacates it. As borrowers are not required to make any repayments, the debt grows and the capitalised interest will compound.
Your choice of payment type
A reverse mortgage can be taken as a lump sum, as regular payments or as a line of credit that allows money to be withdrawn irregularly as required. Or it can be taken as a combination of these methods. Retirees should check whether borrowing money against their home could affect their entitlement to receive Centrelink benefits.
Several institutions instrumental in establishing the local market are no longer lending, as the credit crunch made it difficult for them to raise sufficient money to fund the loans. Those still offering loans do not lend as generously as previously – but there are plenty of options available for retirees whose superannuation and share portfolios have fallen dramatically.
A free, independent information service run by the government-funded National Information Centre on Retirement Investments (www.nicri.org.au) has been swamped with calls from people struggling to make ends meet.
“We’ve had 3000 calls in four months, which is an awful lot of people interested in finding money somewhere,”says director Wendy Schilg. “These people are asset-rich but cash-poor and really need to top their pension up.
“There is a feeling that the financial crisis could go on for a while yet [so] people are looking at where they can get that bit extra to fix up their homes or make their lives more comfortable, or liveable.”
The reverse mortgage market grew by 8 per cent in the six months to December 31, 2008 and 23 per cent in the 12 months to the same date. More than 37,500 loans worth $2.5 billion are held by retirees, according to the latest Deloitte SEQUAL Reverse Mortgage Study.
RBS Group’s head of reverse mortgages, Martin Lynch, says nearly a third of its customers spent their loan funds on maintaining their homes, while just under a fifth used the cash to bolster their regular income. Unsurprisingly for someone selling reverse mortgage loans, Lynch is upbeat about their use and proclaims that “[a regular] income stream of $200 can totally transform a retiree’s life, without significantly
eroding the equity in their home”.
But a reverse mortgage will not suit everyone. And those who do opt for a loan need to understand clearly how the products work and the dynamics that affect the equity that remains once a property is sold. The Australian Securities and Investments Commission has released a guide to help with the education process.
The first factor to understand is that flat or falling property prices and rising interest rates can quickly erode equity in a home that could be needed later in life. While average house prices rose by about 4 per cent over the first half of 2009, reversing a similar drop over 2008, the prospect of further job losses and rising unemployment will work to limit the speed of the housing price upswing.
Another downside for borrowers is that the moderate recovery in the housing sector is limiting the need for the Reserve Bank of Australia to further reduce its benchmark official interest rate.
Sharp job losses from here will be the main spark for any further cuts, with several economists now predicting that rates have bottomed at 3 per cent and that the next move probably is up.
Deloitte Actuaries and Consultants partner James Hickey crunched some numbers to show the impact of each of these factors.
Something left behind
“One of the major benefits of reverse mortgages is that they allow retirees to access money now as well as potentially maintaining a valuable inheritance for their beneficiaries,” Hickey says. “While this property equity inheritance will be less, there can still be considerable equity to pass on.”
After establishing the market value of a property, a lender will decide a loan-to-valuation ratio (LVR) based on the borrower’s age. The LVR is the maximum amount the borrower can borrow.
The older the applicant, the more they can borrow. The typical LVR for a 70-year-old is 20 per cent. So on a house valued at $300,000, a 70-year-old could typically borrow up to $60,000. Research shows borrowers aged up to 70 draw down most of the available cash but those over 75 use about half of their loan facility.
One of Hickey’s calculations shows that a 70-year-old with a $300,000 house who took a $50,000 lump-sum reverse mortgage at 6.75 per cent interest would have net equity of $325,000 after 10 years and $410,000 at age 90. This assumes that the property’s value grows at 3.5 per cent each year. But if the house value remains stagnant for five years at $300,000 and then grows at 3.5 per cent a year, the remaining equity would fall to $260,000 at age 80 and $320,000 at age 90.
If interest rates rose to 8.75 per cent a year and the house value grew at 3.5 per cent a year, the net equity at age 80 would be $305,000 and $330,000 at age 90.
If establishment fees and charges are added to the loan, the loss of equity will be even greater.
And if the reverse mortgage is taken as regular income, it would have an impact on the equity in a home in the short term. The downside is that compound interest payable in later years could be considerably higher.
If the same 70-year-old took a reverse mortgage as an annual income stream of $5000, the net equity in a home would be $350,000 at age 80 (it was $325,000 if taken as a lump sum) and $390,000 at age 90.
This assumes property price growth of 3.5 per cent a year and an interest rate of 6.75 per cent.
The total outstanding debt could be higher than if the borrower had drawn down $50,000 initially.