When is using the cash tied up in your home to fund retirement a sensible idea?
Using the equity in your home for some extra spending money may sound tempting, but there are times when you should not consider this an option.
There are two types of financial products designed to release a home’s equity: reverse mortgages and home reversion schemes.
Generally, you need to be more than 60 years of age to access these products.
The MoneySmart website warns against drawing loan funds secured by your home to top up bad spending habits or for other investments.
The main danger in using a reverse mortgage to invest is that you risk losing your entire home if the asset performs badly.
However, it is justifiable to tap into your equity if you need an urgent medical procedure or home repairs you can’t otherwise afford, according to the Australian Securities and Investments Commission-sponsored site.
Rarely in history have seniors seen the meteoric rise in home values that Australians have witnessed in the past decade. But just because your house may be worth 10 times more than what you originally paid for it, it doesn’t necessarily mean you should splurge.
Importantly, MoneySmart advises against taking an income stream in return for the capital growth on your home.
According to MoneySmart, the cashflow may look attractive, but the income received will probably be much lower than the capital appreciation of the home that is being sacrificed. MoneySmart advises that such offers “are unlikely to be covered by credit or financial services laws, meaning you will not have access to important consumer protections such as free external dispute resolution.”
Reverse mortgage lenders do not require borrowers to have an income and you can continue to live in your home as long as you like.
But, just like any other type of loan, you will be charged interest and it is likely to be at a higher rate than on ordinary home loans. You do not have to make any repayments on the reverse mortgage until you sell your house or die.
However, the interest compounds and is added to the loan balance with the total having to be eventually paid back in full. MoneySmart estimates that thanks to the compounding interest, a loan of $50,000 can turn into a $232,000 debt after 15 years and more than $1 million after 30 years.
Accessing your home’s equity could affect your Age Pension. And if the debt that has to be repaid to the lender is huge, you may not have enough money left over to secure a place in the aged care facility of your choice.
If you live in Melbourne or Sydney, you may be eligible for a home reversion scheme. Under this complex arrangement, you sell a portion of the future value of your house to the organisation handing you the funds.
MoneySmart warns that the risks of entering into such a scheme include:
- you don't know what the actual cost is
- your circumstances and financial views might change as you age; if you use too much money now, you may find you do not have enough later on
- your pension eligibility may be affected by the lump sum you receive and how you use it.
Before deciding on releasing equity in your home, speak to a respected financial adviser or lawyer, especially one who specialises in retirement planning.