Home is where the cash is

Is a reverse mortgage right for you? Retired actuary and author John De Ravin takes us step by step through the strategy.

Home is where the cash is

Retired actuary and author John De Ravin knows a thing or three about personal finance and insurance. Acknowledging that our retirement income system can be complex, he explains the key financial strategies that can help pre-retirees and retirees in his book, Slow and Steady: 100 wealth building strategies for all ages. In this chapter, ‘Taking out a reverse mortgage’, he takes us step by step through the strategy.

•••

Read this strategy if:

  • you are retired and own your own home with little or no current mortgage, and you would like to boost the amount of cash you have available for current spending
  • if you are on a part Age Pension, the Pension Loans Scheme does not meet your needs
  • you are happy to use some of your home equity, recognising that this will diminish the size of your estate that will ultimately be inherited by your beneficiaries.

Background
Many Australians will reach retirement owning their own home and wanting to continue to live in their own home, but perhaps having other assets (superannuation balances, shares, bank deposits, etc) that are not quite sufficient, on their own, to produce the lifestyle that they would like in retirement.

Key point
A possible solution to the ‘asset rich but cash poor’ challenge is to take out a reverse mortgage. Essentially, this means borrowing against your home to get money that you can use to improve your lifestyle. Normally, the loan is made on the basis that repayments are not required and you cannot be forced to sell your house to repay the loan. Instead, your home will be sold when you pass away or move out of home but, since legislation was introduced in September 2012, the lender is not permitted to recover any money from you (or your estate) other than the proceeds from the sale of the home even if the proceeds of selling the home are less than the outstanding balance of the loan. Because of this ‘no negative equity’ guarantee, the interest rate is higher than banks would normally charge on a home mortgage.  Currently (March 2020), reverse mortgage interest rates range from 5.15 per cent to 6.30 per cent, at a time when:

  • standard mortgage rates were typically in the vicinity of three to four per cent
  • borrowers with low credit risk could get discounts on the standard rates, enabling them to borrow at interest rates below three per cent
  • the cheapest standard mortgage offerings were at rates of about 2.5 per cent.

Also, because the lending institution is aware that you don’t have much capacity to repay the loan and the loan amount will just accumulate with interest until the time when you move out or pass away, the lender will only be prepared to lend a relatively small percentage of the value of the home, nothing like the 80 per cent that lenders may typically lend where regular repayments of principal and interest are being made. According to the ASIC MoneySmart website, typically lenders will be prepared to lend 15–20 per cent of the value of your home if you take out the reverse mortgage at age 60, but the percentage that they may be prepared to lend increases by about one per cent for every year of age. So, for example, if you only take out a reverse mortgage at age 70, lenders may be prepared to lend about 25–30 per cent of the value of your home.

ASIC has prepared a reverse mortgage calculator that is available on the MoneySmart website. The calculator allows you to input the specific details of the reverse mortgage you might be considering taking out, including:

  • your age and gender and (if applicable) your partner’s age and gender
  • the current value of your home
  • the assumed rate of increase of the value of your home per annum
  • the loan interest rate
  • the loan establishment fee
  • the ongoing loan fees
  • whether you want to draw down your loan as a lump sum, or several lump sums, or as a regular payment, and at what times and for what periods.

The output of the calculator is a graphic that shows how much remaining equity you have in your home after various future periods. You can modify the periods at which the calculations are done to show the dates or a range of dates in which you are interested. You can determine what lump sums or what regular income amounts you would like to draw from your reverse mortgage and the calculator allows for the establishment fee and regular operating fees for your mortgage.

How to do it
After reviewing the general information on reverse mortgages, have a look at some of the comparison sites and, if it is clear to you which lender’s offering is best suited to your needs, you can approach that institution directly and ask them to provide you with an application form.

If you are not sure, or find the application process difficult, then it may be more straightforward to proceed through a broker.

What does it mean for you financially?

A reverse mortgage means that you have the ability to improve your lifestyle without actually selling your home. You can take the proceeds either as a lump sum (especially if you need cash for some specific, one-off purpose) or you can take the proceeds by drawing down on your credit limit over a period of time. Either way, you get to live the lifestyle you want to live, without moving out of your own home.

It should be noted, however, that although taking out a reverse mortgage will not adversely affect you, essentially you are borrowing against what is likely to be your main asset – your home. When you move out or pass away, the remaining equity in your home (after paying off the amount to which your reverse mortgage loan has accumulated) will be lower than if you managed to avoid the reverse mortgage. Also, if you need to raise a deposit to move into an aged care home, the proceeds from selling your home will be lower than if you hadn’t taken out the loan and this may mean you can’t afford to move into the aged care facility you prefer.

Factors to take into account before you decide

Given that a reverse mortgage generally allows you to live a nicer life but at a cost to your estate, one of the questions you might like to consider is what legacies you would like to leave to your beneficiaries. Some retirees are quite happy to go on SKI holidays (‘spend the kids’ inheritance’) but others are determined to leave bequests for their children, relatives, friends, charities or other beneficiaries. If you own your house and manage to get by on the Age Pension (and whatever other assets you may own), then you will always leave the family home to your beneficiaries. If you take out a reverse mortgage, depending on how much of the mortgage you draw on and how long you remain in your home before it is sold, it may be that little or no equity in your home will remain to be inherited by your beneficiaries.

Also, if you are receiving the Age Pension, there may be an impact on your pension entitlement. The reverse mortgage drawdowns themselves are not counted as income for the purpose of the means test, but if the borrowed money is then held as a financial asset (such as a bank account), then the money in the bank account (apart from the first $40,000 for the first 90 days after you draw down the loan) is counted as an asset for means testing purposes. 

Slow and Steady is available from John De Ravin’s website for $39.95.

Are you considering a reverse mortgage? Are you concerned that a reverse mortgage will affect your children’s inheritance?

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Financial disclaimer: All content on YourLifeChoices website is of a general nature and has been prepared without taking into account your objectives, financial situation or needs. It has been prepared with due care but no guarantees are provided for the ongoing accuracy or relevance. Before making a decision based on this information, you should consider its appropriateness in regard to your own circumstances. You should seek professional advice from a financial planner, lawyer or tax agent in relation to any aspects that affect your financial and legal circumstances.

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    COMMENTS

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    Migrant
    26th Mar 2020
    11:41am
    Hi John,
    An excellent article on reverse mortgages, pointing out the pros and cons of taking a reverse mortgage on your home.
    Australia makes it complicated with Income Tax, andthe impact on Age Pension to be considered, as well as the resultant effect on your estate and its taxation.
    It would be so much easier if the Age Pension was a Universal Pension to all payable from the expection of life less five or ten years...so that if the expectation was 80 for males and 83 for females then the pension ages would be M 70 and F 73, and would change with every publication of the Australian Life Tables. In this “brave” new world the pension would be taxed as income in the year of receipt.
    Migrant.
    PS. Like you I am a retired Actuary. Best profession for anyone with a mathematical bent.
    Triss
    26th Mar 2020
    2:06pm
    Call me cynical but I don’t trust any government strategy that gives it any kind of say over my property. We have seen how governments have changed goalposts and rules for pensioners and pensions always to the detriment of said pensioners.
    Crusty
    26th Mar 2020
    5:49pm
    I am a big fan of the Pension Loan Scheme, suits me very well. Low entry fees, current interest rate 4.50% much less than the 'commercial' rates listed in your article, can be stopped and started at any time. Cons include: You only get a statement once a year, must make any credits by cheque sent in the post (last century technology) and of course a big lump sum is not an options. Horses for courses.
    tams
    29th Mar 2020
    8:14am
    Congratulations on your article John. Exceptionally well written and explained.

    I have been a reverse mortgage adviser for 16 years and must highlight that a reverse mortgage is not for everyone. Many don't have a need whilst, as pointed out, many can get by on the Age Pension.

    We will be seeing greater demand over the next 12 months, as returns from investments and lower asset values will affect the financial position of many retirees.

    And older Australians who will lose their employment may be faced with existing debts that will require some form of servicing. A reverse mortgage may be an answer.

    Paul Dwyer
    Reverse Mortgage Finance Solutions
    tams
    29th Mar 2020
    8:14am
    Congratulations on your article John. Exceptionally well written and explained.

    I have been a reverse mortgage adviser for 16 years and must highlight that a reverse mortgage is not for everyone. Many don't have a need whilst, as pointed out, many can get by on the Age Pension.

    We will be seeing greater demand over the next 12 months, as returns from investments and lower asset values will affect the financial position of many retirees.

    And older Australians who will lose their employment may be faced with existing debts that will require some form of servicing. A reverse mortgage may be an answer.

    Paul Dwyer
    Reverse Mortgage Finance Solutions