Two strategies that can boost homeowners’ retirement income are the reverse mortgage and equity release. Here’s what you should know about these schemes.
A reverse mortgage
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
- you are happy to use some of your home equity, recognising that this will diminish the size of any estate that will ultimately be inherited by your beneficiaries.
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 (April 2021), typical reverse mortgage interest rates are in the vicinity of 5 or 6 per cent at a time when standard mortgage rates are typically in the vicinity of 2 to 3 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 accumulate with interest until 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, lenders will typically 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 that percentage increases by about 1 per cent for every year of age. So, for example, if you 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 a reverse mortgage calculator available on the MoneySmart website.
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, a question you might like to consider is the 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 in 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.
Selling equity in your home
Read this strategy if:
- you are retired, own your home with little or no mortgage and you would like to boost the funds you have available for spending
- you are not keen on a reverse mortgage because you want to be sure that a certain percentage of the equity in your property will still belong to your estate, no matter how old you are when you pass away.
Australians have an alternative way of tapping into the equity in their homes to provide additional funds for current living expenses, or to meet urgent one-off expenses. You can sell a percentage interest (say 50 per cent) in your home to a financier and receive a discounted value of that interest.
When you sell your home, or when you pass away, the lender is entitled to the agreed percentage of the sale proceeds of your home. With a traditional equity release product, you receive only a discounted value of the share in your home’s value though, because:
1. the acquirer is not entitled to receive any rental income from the property and
2. the acquirer is not permitted to sell your home to recover their money until you decide you want to sell (or you and any surviving spouse pass away). The younger you are, the higher the discount because the sale of your property and payment of the share to the acquirer may not occur for a very long time.
This form of tapping into the equity in your home is known as a home reversion scheme or sometimes as home equity release. More detail about home reversion schemes is provided in an article on the ASIC MoneySmart website.
If you are considering a home reversion, probable criteria are as follows:
- homeowners must have attained a certain minimum age, typically 55 or 60, at the date of contract
- homes must be within eligible postcode areas (mainly Sydney and Melbourne)
- homes must be freestanding, or if a unit or strata property, there must be no more than six dwellings on the title plan (excludes apartments)
- the property is the principal place of residence for at least one homeowner at the time of exchange of contracts
- the land value of the property is 60 per cent or greater of the total market value of the home
- all permanent residents in the home are shown as property owners (or have an interest) on the certificate of title or can be added as required
- homeowners have no debt on their title or all existing mortgages can be discharged before, or at the contract date.
An alternative, the ‘fractional equity release’ model, has also been developed in the past few years. Under the terms of a fractional equity release transaction, you sell a proportion of the equity in your home to the purchaser, but in this case, you will be liable to pay the appropriate proportion of the gross rent for your property to the purchaser (though it may be possible to sell additional fractions of your home over time to avoid the need to pay such rents to the purchaser).
The advantage of a fractional equity release transaction from the seller’s perspective is that the seller will receive a higher proportion of the value of their home in cash at the date they enter into the fractional sale contract. The disadvantage relative to the more traditional equity release model is that you must pay rent on the fraction of your property you have sold.
What does it mean for you financially?
Essentially, the consequences of a home reversion are that you will receive money from the acquirer now and can do whatever you want with it. There are no constraints on how you use your home; you can even move out and rent out your property if you wish. You do not have to sell your home when you move into aged care (though you might need to sell your home if you are trying to assemble an accommodation deposit, so you can enter the aged care home of your choice).
Of course, the consequences are borne by your beneficiaries in the sense that when you pass away or whenever you choose to sell your home, the acquirer will be entitled to the agreed share of the sale proceeds.
Unlike the situation with a reverse mortgage, where it is impossible to know in advance what percentage of the equity in your home will remain after you have paid off the loan, you always know what percentage of the proceeds of selling your home you (or your estate) will be entitled to on sale: it is simply 100 per cent less the share that you have sold to the acquirer. However, no-one is in a position to know the dollar amount that will go to the acquirer until the property is finally sold.
Before you decide, consider these factors
1. Depending on what you intend to do with the proceeds, if you are a full or part age pensioner there may be implications for the amount of Age Pension you will receive. If, for example, you hold the proceeds of the home reversion as financial assets, those assets will be subject to the assets test and also the assets will be subject to ‘deeming’ for the purposes of the income test. If you are a part pensioner, the amount of pension to which you will be entitled is likely to be affected. If you are a full pensioner and the amount you receive from the home reversion is sufficient to breach the minimum threshold for the assets test or the income test, you will lose at least part of your pension. You should check with Centrelink on the likely outcome for your pension entitlement.
2. The home reversion decision has implications for your estate, since only a proportion of the proceeds of the sale of your home will fall to your estate. (Also, of course, you can’t leave your home to one of your beneficiaries because after you and your spouse have passed away, under the terms of the contract, the home will have to be sold so that the acquirer can be paid their share of the sale proceeds.) If you are considering using a home reversion scheme, it is worth discussing your intentions with your beneficiaries.
3. It is worth considering the situation that may arise later in life in the event that you can no longer look after yourself and you need to go into an aged care facility. If you have used the value of your home towards your current consumption, will selling the remainder provide you with a sufficient lump sum to fund your aged care accommodation deposit?
Have you investigated these strategies? Are you confident your retirement or your plans are on track?
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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.