Releasing equity in a home requires serious thought
Reverse mortgages can be attractive to retirees seeking to unlock some of the equity in their house. Also called ”equity release”, reverse mortgages are generally available to those who own their homes and are aged over 65, though some will lend to over 60s. The loan can usually be taken as lump sum, a line of credit or an income stream.
There are no repayments on the loan. Once the house is sold, the surviving borrower dies, or the borrower moves into aged care or a retirement village, the loan is repaid in full.
Under new credit laws to come into effect for reverse-mortgage contracts entered into from March 2013, many of the standards that apply to providers who are members of the industry association SEQUAL (Senior Australians Equity Release Association) will apply to all providers.
There are some additional measures. Borrowers will have to obtain independent legal advice on the contract, as well as be shown by the provider how quickly the loan will grow.
Because of the importance of ”no-negative guarantees”, all providers were required to have the guarantee from September. The guarantee means if there is a shortfall in covering the debt on the sale of the house, the lender wears the loss.
The debt can grow much larger than the amount borrowed, says Craig Hall, the executive officer, media and communications, at the National Information Centre on Retirement Investments (NICRI). Because no repayments are made, the interest is capitalised, or added, to the loan. With standard mortgages, the borrower makes regular payments of interest and capital and the debt reduces. With reverse mortgages, because of the compounding of interest, the debt grows. ”It is surprising the number of people who ring in who do not understand the effect of the compounding over many years,” Hall says.
Other options for raising cash should be explored first, such as selling investments, and borrowers should seek independent financial advice, not just legal advice on the contract, Hall says.
Not only can reverse mortgages affect Centrelink entitlements, such as the age pension, but borrowers should have a plan for when they are looking at going into aged care, he says. Those considering a reverse mortgage should consider the Pension Loans Scheme administered by the Department of Human Services. Under the scheme, those drawing a part-age pension and who own property can access a loan that is repaid when the property is sold. The loan can be taken only as an income stream and not as a lump sum. And the maximum that can be borrowed is limited to the amount that produces an income equal to the gap between the part-pension and the age pension maximum.
Self-funded retirees who own property can access the scheme, but there are restrictions. They must be ineligible for the age pension under either the income test or the assets test.
If they are ineligible for the age pension under both tests, they are ineligible for the Pension Loans Scheme.
As well as being administered by the government, another attractive feature of the Pension Loans Scheme is that the variable interest rate is only 5.25 per cent a year. Reverse-mortgage providers charge interest of between about 7.2 per cent and 7.8 per cent. The lower the interest rate, the more will be left over when the house is sold.
For information on reverse mortgages, phone NICRI on 1800 615 676 or see nicri.org.au.