Equity release products, better known as 'reverse mortgages', are not new. They were developed in the United Kingdom in the 1920s and made their way to the United States in the 1960s. Even Australia has tried them when the Advance Bank trialed the product in 1996, but withdrew it soon afterwards as a result of consumers' lack of familiarity with the concept.
Unlike conventional mortgage products, reverse mortgages focus exclusively on a specific segment of the population: retirees. They allow retiring homeowners to access a largely untapped asset to fund a standard of living that for many would otherwise be out of reach. And it seems their reintroduction to the Australian market is timely.
Figures released by the Australian Bureau of Statistics show the average man can now expect to live until 77 and the average woman until 82. Men and women born in the 1920s could expect to live to the age of 59 and 63 respectively, meaning that with every decade that passes, life expectancy grows by an average of four years. These trends mean that the proportion of the population who are aged 65 years and over will roughly double over the next 40 years, to almost one in every four Australians by 2042.
Australians retiring in their 50s and 60s can now expect to spend two to three decades in retirement. At the same time, there will be almost zero growth in the number of Australians of workforce age. As a result, the elderly dependency ratio — people aged 65 years or more to the working age (15-64 years) population — is projected to increase from 18 per cent in 2000 to more than 37 per cent in 2050.
Retirees have generally had to depend upon government pensions to either fund their retirement or supplement their income from personal superannuation plans and savings. However, the majority of retirees also own a significant asset - their homes. A report into funding the retirement of the baby-boomers, states that the average 50-64 year old has accumulated $240,000 of assets: about two-thirds higher than the national average.
Equity in a person's home stands out as a major difference between 50-64 year-olds and the adult population as a whole — with an average home equity of $127,000 for 50-64 year olds versus an average of $77,000 for all Australian adults. The difference reflects the older group having a combination of higher overall ownership rates, with a higher proportion owning the home outright, or having smaller mortgages where they still exist.
Not surprisingly, the superannuation held by 50-64 year olds is considerably above average as well, with an estimated average of $56,000 for all 50-64 year olds. However, this analysis reveals that more than half of a retiree's total wealth is tied up in the family home.
Most financial planners suggest that a retirement income needed for a comfortable standard of living is about 60-65 per cent of the retiree's final full-time salary. This equates to around $30,000-$35,000 per year, or around $600 per week.
Assuming that an average retiree does not use his or her superannuation payout for other purposes, a $56,000 lump sum paid by a 65-year-old male into an allocated annuity, will provide an income of only $100 a week up to age 80 (just short of an average life expectancy age). In other words, it will provide a supplement of $100 to the pension, giving a total income of around $300 per week — still well short of the suggested $600 needed to be comfortable.
Michael Kingston from Infinity Financial says that most retirees have access to sufficient superannuation in the initial years of retirement, so there is not a great need to borrow money early on. "The funds from reverse mortgages taken in the first couple of years of retirement are usually for things like a holiday or new car," Kingston says. "It's the latter years when savings and super are nearly gone that older people need to access a larger percentage of funds in order to maintain a quality lifestyle."
He warns that with Australians now living longer, there is a very real chance that people will outlive their savings.
If retirees choose to retire early and spend their lump sum, then they can look forward to many years on the very modest standard of living provided by the age pension with no supplementation. This is where a reverse mortgage can come in handy.
How they work
Reverse mortgages are similar to conventional residential mortgages in that the borrower raises funds against the security of the home. However, reverse mortgages are very different to conventional mortgages when it comes to drawdown, cash flow, and repayments.
In a normal mortgage, the principal amount of the loan is generally advanced as a lump sum to the borrower in order to a purchase a property. The borrower must then make regular principal and interest payments during the term of the loan. If the borrower defaults on the loan, the lender may recover the outstanding balance of the loan (including any unpaid interest) by enforcing its mortgage and selling the mortgaged home.
That is not the case with a reverse mortgage. In addition to having the option of receiving the principal in an upfront lump sum payment, the retiree can also choose to receive the principal in the form of regular part-payments from the lender during the term of the loan.
The retiree is not required to make any repayments (whether of principal or interest) to the lender during the term of the loan, however in some cases may have the option to do so. Instead, the entire loan (including accrued interest) falls due on the death of the retiree, or when the retiree moves out of the mortgaged home permanently, for example into a nursing home or if the property is sold.
The lender then recovers the loan by either having the beneficiaries of the retiree's estate pay the debt, or by enforcing its mortgage and selling the mortgaged home. In most cases, the lender will give the retiree's beneficiaries up to six months to finalise the debt. If the lender sells the property, they will give any funds left over to the estate of the retiree.
While offering a flexible product to retirees, it seems lenders are also taking steps to ensure that retirees enjoy longevity of their finances. Most lenders will limit the loan-to-value ratio (LVR) to around 15 per cent for those aged 65, and will increase the maximum LVR as the borrower's age increases, in some circumstances up to 45 per cent of the value of the property for those aged 80 and over.
Dr Nicholas Gruen, founder and chief executive officer of Peach Home Loans believes it is good for older people to be able to access their assets without being forced out of their home.
"The drawback of the product is that there are some very strict limits on how much equity can be accessed," he says. "Reverse mortgages carry much higher interest rates, reflecting the additional risk to the lender, and this can often force pensioners into the more expensive asset-lending market."
He adds that many older Australians would prefer to take a reverse mortgage as it cannot be foreclosed upon, even if it means meeting the additional costs and restrictions. "However, pensioners shouldn't pigeonhole themselves into thinking that this is the only option open to them," he says. "Being well informed about other products may mean the difference between comfort and poverty."
Breakout Box: Spotting the traps
In a recent article entitled: "Putting it into Reverse", Catherine Wolthuizen of the Australian Consumers' Association (ACA) stated that reverse mortgages were "...complex, inflexible and carry risks. They limit future options for how the value of the family home may otherwise be used, reduce the value of the estate and impact on eligibility for Centrelink payments. They are typically sold to older consumers, who have been recognised as possibly more vulnerable. As with other areas of credit activity, unscrupulous and unqualified operators may move into selling these products as long as they remain unregulated.
"ACA acknowledges the value and appeal of these products but we are anxious to see that the market develops so as to provide high-quality, competitive and flexible products appropriate to the needs of consumers who take them up. At present, the market is not delivering the flexibility or security we believe is appropriate for consumers to take up these products with confidence."
It has long been a social trend for many retirees to think that they must have an asset to leave their children. Peter McGuinness, chief executive officer of Bluestone Equity Release, says many retirees skimp on important things such as health care so that they can maintain a property to leave to their children. "The ironic thing is that most children would prefer their parents live out their twilight years in relative comfort and good health, rather than ensure they leave a good inheritance," he says. "Through reverse mortgages, retirees can have access to regular funds to supplement their income and savings, and enjoy a better quality of life."
While there are advantages to reverse mortgages, it is important to discuss your options with your financial advisor and family before entering into a contract. Unless you sell your property and pay back the loan prior to your death, the beneficiaries of your will may be left with a property that has an outstanding loan secured against it. This may come as a nasty surprise if it wasn't expected, and can often add to the grief being felt by loved ones.
Break out box: - Current regulatory arrangements
As reverse equity mortgages have only re-emerged in Australia recently, they are not subject to any specific regulation. Responsibility for regulating their sale rests with the State governments, rather than with Federal Government. While the Uniform Consumer Credit Code covers some aspects of the provision of credit, it is silent on some of the issues specific to reverse mortgages. There is no specific government legislation relating to reverse mortgages.
Providing a SEQUAL
Given the potential market growth for senior equity release, a number of lending institutions have formed the Senior Australians Equity Release Association of Lenders (SEQUAL). Sequel was launched in January this year and is a not-for-profit association supported by nearly all of Australia's leading providers of equity release products. SEQUAL's executive director, Kieren Dell, says that the aim of the organisation is to provide consumers with safeguards and set standards for the [reverse mortgage] industry.
He adds that all members of SEQUAL have voluntarily agreed to adhere to the SEQUAL Code of Conduct, and most are members of the Mortgage Industry Association of Australia. When considering an equity release product, Dell has the following suggestions:
- Look for products that carry a clear 'no negative equity' or 'non-recourse' guarantee. This means you can never owe more than the net value of your property, provided the terms and conditions of the loan have been met.
- Discuss your proposed loan with family members or close friends, particularly if they are likely to be named as a beneficiary in your will.
- Seek independent financial advice from a qualified financial adviser.
- Discuss the transaction with Centrelink to ensure you fully understand any impact on any Centrelink benefits.
- Obtain independent legal advice from your solicitor.
- Make sure you have assessed all the costs associated with the loan.
- You should not be obligated to purchase any other product or service in order to receive an equity release product.
- Ensure that you are given a written package of equity release documents, covering the benefits and obligations of the product. This must include the potential effect of future house values, interest rates and the capitalisation of interest on the loan.
- Ensure that the loan you are about to sign is written under the Uniform Consumer Credit Code (UCCC).