Reverse mortgages: How the new rules affect you
Retirees worried about income, thanks to lower interest rates, have a new way to dip into the equity in their property. We outline what's available.
From Monday, more retirees will have a new way to tap into the equity in their homes, providing regular cash payments at much cheaper borrowing rate than traditional reverse mortgages. The expanded government-backed opportunity for increasing household cash flows arrives as record low and falling interest rates are forcing retirees to consider new ways of using their retirement savings and capital to generate income without taking big risks. “Lower rates are beginning to bite those retirees living off interest-bearing investments such as term deposits,” says Paul Moran, principal of Moran Partners Financial Planning, about the outlook for interest rates and investment returns. “Typically, these same people have tended to be risk-averse and would have perhaps been uncomfortable with a reverse mortgage in the past. But times have changed and money is probably the tightest it has been for retirees for some time.” Huge amounts of money are chasing income-generating assets, such as shares paying high dividends, which is driving up their price and lowering the yield, a potential trap for many investors. That makes transparent, competitively-priced schemes for releasing equity in family homes a more attractive option. The government-backed Pension Loans Scheme (PLS) is more flexible and cheaper than commercial options and encourages borrowers to top up income, rather access lump sums. An earlier scheme has been revamped and is available to more retirees. Many of the four million Australians aged over 65 (representing about 15 per cent of the population) who own their own homes have built up large reserves of equity, despite recent property price falls. For example, someone who paid off a median-priced house in Sydney over the past 30 years has enjoyed a six-fold increase in the value of their property from about $171,000 to about $1 million. It’s the same increase in Melbourne where the median price in 1989 was $132,000 is about $800,000.
Retirement income needs
That's a good start for self-funding retirees because industry experts estimate single people who own their own home and are in relatively good health need $454,000 – and couples $640,000 – to achieve a comfortable retirement. A lump sum in this vicinity will allow for annual spending of about $43,000 for singles and around $61,000 for couples. The Association of Superannuation Funds of Australia (ASFA) defines “comfortable” as being able to pursue a range of leisure and recreational activities, as well as afford private health insurance and occasional international holidays. In addition to the government's expanded PLS, products for those considering equity release include traditional reverse mortgages, specialist home reversion schemes and, more recently, schemes based on selling a share in the property, rather than debt. There’s also downsizing, which is popular with many Baby Boomers seeking a lifestyle sea (or tree) change but increasingly risky in volatile property markets. Total transaction and moving costs could account for up to 10 per cent of sale proceeds, according to analysis by Wakelin Property Advisory, an independent buyer’s agency. An added issue is having to move away from family and friends. The big potential disadvantage from any reverse mortgage (including the government scheme) is compounding interest rates could take a big bite from the estate when the borrower dies and the outstanding loan is paid. “This leaves less inheritance for the family,” says John Perri, AMP’s technical strategy manager. Brendan Ryan, principal of Later Life Advice, says retirees need to find the right mix of income from investment earnings, capital, government support and releasing home equity. “This is quite a complex mix to get right that is different for everyone,” he says.
Pension Loans Scheme
The government’s revamped scheme has been expanded to include full and part pensioners and some self-funded retirees with securable real estate assets in Australia. “That means it will be open to everyone above age pension who owns a home,” according to the Department of Social Services. Australia recently reached a milestone, with most new retirees having enough savings to be self-funded rather than reliant on the age pension, according to new research. More than half those aged 66 were not accessing the age pension as at December 2018 because their assets and income were too high, while 20 per cent were on a part age pension. Only 25 per cent were drawing a full age pension. Under the PLS, single participants on the age pension will be able to access up to $1389 a fortnight (in pension plus loan). For couples it is $1047 each a fortnight. Self-funded retirees can borrow up to the full amounts of $36,000 for singles and $54,000 for couples a year. The interest rate is 5.25 per cent compounding on the outstanding loan amount compared to 6.54 per cent on a commercial reverse mortgage. “The scheme is clearly more designed for those who want a top-up of, say, $1000 a month,” says Moran. You are unable to apply for lump sums under this scheme. AMP’s Perri says: “Interest is added to the outstanding loan balance each fortnight until it is repaid in full. The longer it takes to repay the loan, the more interest is paid.” Repayments can be made at any time. Borrowing is capped by property value and the debt must be repaid when the family home is sold. “Spend it, or it may be counted for Centrelink,” warns Perri. “Any borrowings should be consumed to meet living or unexpected expenses and not used to prop up savings. Any increase in savings will be counted by Centrelink under the means test, which could result in a reduction in age pension." Further, an applicant needs to be receiving less than the full pension, but must still be able to qualify for the age pension under either the asset test or the income test, adds Moran. “While this seems a little confusing, it means that if you are knocked out of the age pension because you have too many assets but would qualify because of a low income, you are likely to qualify for this scheme,” he says. Dipping into home equity should not be seen as a first resort, and retirees should be using income from available assets such as superannuation pensions, savings and other investments first, he says. "But as these become exhausted it may be appropriate to consider these options to maintain your lifestyle," he adds.
Traditional reverse mortgage
The number of providers has shrunk from about 10 to three in the past three years amid concerns that high compounding interest rates and fees rapidly consumed equity, according to Canstar, which monitors rates and fees. These products provide regular payments or a lump sum, rather than an income flow that can be stopped, increased or reduced like the PLS. Those considering a commercial reverse mortgage need to shop around because rates vary from between 6.24 per cent to 6.54 per cent. Lenders do not offer fixed rates, which means if official rates rise then so does the cost of the reverse mortgage. Reverse mortgages typically have an interest rate around 100 and 125 basis points higher than the government scheme. The amount that can be borrowed varies between providers. For example, Heartland Seniors Finance has no maximum while IMB Bank has a top limit of $1 million. There are also upfront fees (which range from $395 to $495) and maximum loan-to-valuation ratios (between 18 per cent and 40 per cent, depending on the age of the applicant). Financial advisers claim there could be a psychological barrier for people who have paid off their homes to create another debt over it. “Because of the restrictions on who can apply for the government’s upgraded PLS, a reverse mortgage may still be an option,” says Moran. Reverse mortgages typically have an interest rate around 100 and 125 basis points higher than the government scheme, which may be significant over 20 years, he says. “But if you don’t qualify for the government scheme and you need a lump sum, there isn’t much alternative,” he says.
Home reversion scheme
This is a real estate product and not something most financial planners can advise on unless they have a real estate license. It is also only available in selected postcodes, mostly Melbourne and Sydney, and is on offer from Bendigo and Adelaide Bank. The bank agrees to a loan aount and then estimates the borrower’s expected life expectancy to calculate what the amount of equity release will cost over that period. When the borrower dies, that amount is taken from the sale proceeds as a percentage of the property. Take as an example the owner of a $1 million house with an 30-year life expectancy who requests $100,000. If the bank calculates the cost of providing that money over 30 years will be $300,000, then it will take 30 per cent of the sale proceeds. There is a choice of regular payments or a lump sum. The interest rate is the same for both. They are normally paid as a lump sum and can impact Centrelink payments.
Another alternative is "fractional release", which allows a property owner to sell equity in their property. Investors in a senior equity release receive monthly rental income of 3 per cent (net of all fees) and “own” a share of the capital value through units in a segregated sub-fund, according to DomaCom, an investment company. The owner has permanent right of abode, or can rent the property out and retain the rent. Maintenance, repairs and insurance are shared with the investors. When the property is sold, the vendor and investors receive their share of the sale price. This can happen when the vendor dies or if they decide to move.