Homeowners considering a reverse mortgage need an informed assessment of the benefits and pitfalls. CPA Australia’s Third Age Network has prepared a paper to help members give clients the advice they need.
“There is a significant number of retirees in Australia who are asset-rich, usually as owners of their house, but are cash-poor,” says Professor Louise Kloot, of Swinburne University’s Faculty of Business and Law and a key figure in the CPA Third Age Network.
“For these people, if they do not want to sell their house outright, a reverse mortgage can be a very useful tool.”
She warns, however, that reverse mortgages and equity releases have traps and pitfalls, and says accountants and financial advisers have a responsibility to understand what these are and explain them to clients.
Types of reverse mortgage
The most common form of reverse mortgage is a loan from a bank or other financial institution that allows the retiree to borrow money using the equity in their home as security.
The loan is repaid when the home is sold, with the total amount including principal, accrued interest and fees. Most commonly, the loan is taken as a lump sum but there is also the option of a regular income stream or a line of credit, says a paper the Third Age Network has prepared for members.
A variation is an equity release, where a retiree sells a share of the house to a finance provider, calculated on a percentage basis. The retiree continues to live in the property rent free, and when the home is eventually sold the homeowner shares the funds with the finance company.
Kloot says that in many cases, the loan is used for improvements to the property, such as repairs or extensions. Providers require information on what the funds will be used for, and are generally very reluctant to provide the loan if the money is to be passed on to others, such as family members.
Advice on reverse mortgages
Kloot emphasises the need for independent financial advice for people considering a reverse mortgage.
“Because the payback date is often a long way off there can be a tendency to ignore the ongoing costs,” she notes. “The interest charges can build up over the life of the loan. So advisers have to carefully explain how compounding interest works, and ensure that the client understands it.”
There are also implications for Centrelink pension entitlements. This needs specialist advice as the consequences will depend on individual circumstances. Centrelink is likely to require supporting documentation about the loan.
From a regulatory perspective, the Australian Securities and Investments Commission (ASIC) considers reverse mortgages to be a credit product. On a few occasions, ASIC has required providers to change advertising to ensure that customers are properly informed.
The Commonwealth Government passed legislation in 2012 which stipulated that the maximum repayment would be the market value of the property. This was meant to ensure that retirees could not be required to repay more than the sale proceeds of the house.
“That was a good safeguard,” says Kloot, “but people looking at reverse mortgages and their advisers should note that it does not extend to things like real estate agent fees and other costs.”
Fewer lenders are offering reverse mortgages
When reverse mortgages first appeared in Australia in the 1990s they were offered by most of the major financial institutions as well as many smaller ones. Over the past 10 years, however, many lenders have quit the field, mainly due to the low interest-rate environment.
“The institutions currently offering reverse mortgages are Commonwealth Bank (CBA), the CBA subsidiary Bankwest, P&N Bank, and Heartland Seniors Finance,” says William McGregor, senior Industry analyst with IBISWorld, which has produced a research paper on the market and providers.
“The institutions that have provided reverse mortgages in the past have given commitments that the existing contracts will be honoured. But at the moment, and with reverse mortgages having a variable interest rate, there is simply not sufficient margin for them.”
The IBISWorld report notes that industry reverse mortgage revenue declined at an annualised 4.9 per cent over the five years through to 2016-17, to total A$227.8 million. A further decline of 4.5 per cent is expected in 2017-18.
Kloot notes that those providers still in the market seem unwilling to advertise the product.
“There isn’t much in the way of brochures or information sheets,” she says. “You often have to go into the bank and inquire. But reverse mortgage products are occasionally mentioned in the personal finance sections of magazines and newspapers, so there is a continuing trickle of interest.”
CPA Q&A. Access a handpicked selection of resources each month and complete a short monthly assessment to earn CPD hours. Exclusively available to CPA Australia members.
The future for reverse mortgage loans
Despite the pullback by many providers, McGregor believes that the reverse mortgage segment will grow in the long term, as interest rates slowly rise and as the population ages.
Industry revenue is forecast to increase at an annualised 3.4 per cent over the five years through to 2021-22, to reach A$269.8 million.
“Reverse mortgages have a role to play,” he says. “But they need careful consideration, an understanding of the implications, and an eye to the repayment date. It’s the sort of product that requires solid professional advice.”
What retirees and their accountant need to consider from these three options
Option 1: Sell the house and downsize
- Will free up cash
- New legislation suggests retirees can put some of the surplus into superannuation
- If a newer home is purchased, maintenance costs may be reduced
Financial costs may include real estate commission and stamp duty, legal fees, bridging finance, moving costs and purchase of new furniture.
Emotional costs include the search for a new home, preparing a beloved family home for sale and leaving friends and support groups nearby.
Option 2: Sell share of house under an equity release scheme
This option allows the retiree to stay in the house until it is eventually sold, perhaps to enter aged care or on death. Any capital gain or loss is shared and the scheme reduces, or “discounts” the money received upfront, as in this example:
If the home is valued at A$600,000 and 50 per cent of the future value is sold, the seller may receive about A$105,000 – A$180,000 depending on age and life expectancy. The amount of the discount depends on many factors and the true cost of this option cannot be determined until the eventual sale of the property. The more the property grows in value, the more the retiree will end up foregoing.
Option 3: Reverse mortgage
As a general guide, for a 60-year-old, a maximum 15-20 per cent of the value of the home can be borrowed and usually 1 per cent is added for each year older than 60.
Costs may include:
- reduced access to money in future, particularly if needed for aged care
- higher interest rates than for a standard mortgage
- the longer the property is mortgaged, the higher the mortgage becomes
- monthly fees
Aged pension implications must be considered as a line of credit will have different consequences for the pension compared with a lump sum or a regular income stream/drawdown.
A reverse mortgage may be a smart way to quickly generate a Refundable Accommodation Bond while waiting for a sale of the family home when the owners needs to be quickly admitted to aged care.
Are annuities part of your retirement plan?