When a reverse mortgage is the right choice

The National Information Centre on Retirement Investments Inc (NICRI) receives many requests for information or advice on whether an equity release product is the right choice when looking to access funds. NICRI is an Australian Government-funded, independent consumer agency providing information to the general public on investment products.

Over recent years equity release products have become a more recognised option for seniors at times when they may require more funds. Tapping into equity from the family home allows seniors who are unable to obtain funds from other sources, access to finance for a major expense or to top up their income requirements to meet ongoing expenses.

So what are seniors accessing equity for? The main reasons people choose an equity release product include renovations or to carry out maintenance projects on the family home. Other common reasons are for travel, to clear other debt or to top up income requirements to meet increasing day-to-day expenses. Seniors are becoming more open to the idea of accessing equity if it means a better standard of living in retirement.

One type of equity release product is a ‘Reverse Mortgage’. A reverse mortgage is effectively a home loan but there is no requirement to make repayments until a ‘trigger event’ occurs.  Trigger events include selling the property, moving out of the property or death of the owner/s.  Interest is charged on these loans and compounds over time, therefore if no repayments are made in that time, the debt will grow substantially. This can be an issue for seniors who wish to leave an inheritance for family, friends or charities, as part of the proceeds of the property will be required to clear the debt. On the other hand, the property may grow in value over that time which reduces the impact of using up that equity.

Accessing home equity may not always be the most appropriate course of action. You should first check to see if other investment funds are available, or perhaps consider selling an unwanted or non-productive asset. Be aware of pressure from a third party such as non-dependent children, neighbours etc, as often this can result in a detrimental outcome.

One instance where the loan seemed innappropriate was an elderly lady who borrowed the maximum amount available to her and subsequently gave the proceeds to her son for a business venture. Unfortunately the son’s business venture failed which left the elderly lady with a growing debt, therefore reducing her options for accessing equity later in life for other potential purposes such as aged care. Another issue she faces is that when she advanced money to her son she exceeded the ‘gifting rules’ which means that her Age Pension entitlement was reduced. It was clear in this case that while her and her son’s intentions were good, a lack of information and advice has cost her significantly.

The maximum amount that reverse mortgage providers will lend depends mainly on two factors, firstly the age of the youngest homeowner (the minimum age requirement for most providers is around 60) and secondly, the value of the property. So generally, the older the borrower/homeowner is, the higher the percentage of the property they can access. This is referred to as the Loan to Valuation Ratio (LVR). For example, a 60-year-old may access around 10% – 20% of the value of the property, while an 80-year-old may be able to access 25% to 45%. Current LVR details can be obtained from the providers. The reason for LVR thresholds is that a person of age 60 may live for another 30 years or so meaning the compounding debt can be quite significant by the time the debt needs to be repaid. This concern could be compounded if interest rates are high throughout the loan term while property values stagnate or even fall.

An important feature that most providers offer as part of their product is called a ‘No Negative Equity Guarantee’ (NNEG). This means that the debt can never exceed the value of the property at the time of sale, when repayment of the loan is required and other money or assets in the estate will not need to be used to clear the debt. The Government has indicated that this feature will be made mandatory for these types of loans. Currently providers who are members of the Senior Australians Equity Release Association (SEQUAL), the equity release peak body, must have this feature to remain a member and adhere to its own code of conduct.

Despite this a NNEG may be subject to default clauses which can negate the guarantee. Default clauses can include not maintaining the property, malicious damage to the property by the owner, failure to pay council rates and failure to inform the provider that another person is living in the house.

An issue that seniors need to investigate when considering a reverse mortgage is the potential effect on their social security entitlement. If the loan was taken as a lump sum and was spent on an assessable asset, the asset would be counted towards the means test. If the loan proceeds remained unspent and for example were deposited in a bank account, the first $40,000 would not be counted for 90 days while the balance is assessed straight away. This is because bank accounts are assessable. If the proceeds were spent on a non-assessable asset such as the family home or travel then it would not be assessed under the income or assets test. If the loan was progressively drawn down and spent on day-to-day expenses or non-assessable assets then it would also not be counted.

Proceeds are assessed for social security purposes if the funds are used to invest in financial assets, to purchase assets such as cars and boats etc, or if the proceeds were given away and exceeded the gifting thresholds as per the previous example. For more information on assessable assets, gifting rules and the social security treatment of equity release products contact Centrelink’s Financial Information Service (FIS) on 132300.

It is clear that although these products have been available for many years, it is essential that seniors who are considering equity release products seek legal and financial advice to determine if it is appropriate and to gain a clear understanding of how the product works, how to optimise any features and benefits and to fully understand the terms, conditions and default clauses in the contract. NICRI also suggests seniors ‘shop around’ and compare a number of equity release products.

Further information on ‘equity release’ for seniors can be obtained from NICRI toll free on 1800615676, email [email protected] or write to PO Box 1339, Fyshwick ACT 2609. Information leaflets and handy reverse mortgage calculators are also available on the NICRI website www.nicri.org.au.

Prior to acting on information provided in the above article, NICRI strongly recommends you confirm details with relation to your personal circumstances with any relevant government department and your financial advisor/representative.

Provider of reverse mortgages can be found on the SEQUAL website. Here, you can also find a copy of its code of conduct.