Written by Hudson Adviser Michal Park
Like margin loans, reverse mortgages tend to get more than their fair share of negative press with the latter market having shrunk significantly since the GFC - and yet I see a place for both depending upon the extenuating circumstances of the individual concerned.
For those unaware, a reverse mortgage essentially allows older Australians to access equity in their homes. It is a type of loan that allows individuals to borrow money using equity in their home as security, but no repayments are required meaning interest is capitalised to the loan amount.
The loan must be repaid in full when you either sell or move out of your home, or die.
The amount you can borrow is capped, so that, due to statutory negative equity protection introduced by the government in 2012, you can never end up owing the lender more than your home is worth.
So the greatest advantage of a reverse mortgage is that they can unlock equity for retirees, giving them the opportunity to have a lifestyle if they are asset rich but cash poor.
But there’s always a downside.
The greatest downside is that the interest costs compound over time due to the fact that there is no requirement to make any repayments. Interest rates and ongoing fees are also generally higher than average home loans.
An ASIC review into the market released last month suggests that borrowers generally have a “poor understanding of the risks and future costs” of the loans – meaning that whilst taking out these reverse mortgages can meet short term requirements, there is little regard for how longer term requirements may be impacted (eg aged care funding requirements).
Another similar opportunity available is the little known Pension Loans Scheme, which is essentially a voluntary reverse mortgage provided by Centrelink. This scheme is back in the spotlight after a proposal in the 2018 budget making it more accessible. Previously only available to part pensioners and self-funded retirees (of age pension age) at a cap of 100% of the pension, from July 2019 the government will expand the Scheme by making it available to full pensioners with a cap of 150% of the age pension (reduced by pension payments received). The maximum ‘top up’ rates are $11,799 for singles and $17,787 for couples per annum.
Like a reverse mortgage, the pension loans scheme ‘top up’ payments are secured to your home which must be repaid when the property is sold or you die.
It is clear that the greatest downside to this Scheme is the limitation on what can be borrowed. Another disadvantage is that it can’t be drawn down as a lump sum payment.