Rightly or wrongly, many people assume they’ll have to sell their former homes in order to pay for aged care. While this could be the correct decision, sometimes borrowing against the home is necessary or even a better choice, according to renowned financial expert Noel Whittaker.
Debt can be divided into long-term and short-term loans, which are both commonly offered under a mortgage arrangement. Short-term “downsizer” finance is typically a lump sum that is used to fund the purchase of a retirement village unit or pay a refundable accommodation deposit (RAD) while you’re selling your home.
Long-term finance, on the other hand, could fund a lump sum or regular payment with the understanding that your former home will be retained and the debt repaid when you pass away.
“Under a reverse mortgage, the amount you can borrow will depend on your age, whereas with an aged-care loan you can borrow up to 50 per cent of your property value,” said Martin Barry, senior vice president and chief corporate treasurer at La Trobe Financial.
Unlike a normal mortgage, where you need both the asset to back the loan and the income to receive it, a reverse mortgage doesn’t require you to make repayments until much later or towards the end of the loan, according to Whittaker. “It is important to be aware of the effect that the capitalisation (compounding) of interest has on your debt position. Compound interest is a great tool for saving but a real burden for debt,” he said.
Interest rates for these kinds of loans are higher than general mortgage rates, as the borrower does not have to make any payments, which means there’s no cash flow for the lender. “What's more, there is a no-negative-equity guarantee on these products now, so if you live too long, property values drop or interest rates increase (or more than one of these) and [if] your loan ends up worth more than your property, [then] the lender would bear the loss,” Whittaker said.
Hence, it’s important to understand the consequences for your pension and the cost of aged care, according to Rachel Lane, principal at Aged Care Gurus. “Rent from your home is assessable for your pension and the means-tested care fee (MTCF). Borrowing a lump sum reduces the daily accommodation payment (DAP) but can increase the MTCF in aged care. On the flip side, if you keep your house its maximum assessed value is $162,087 and it is exempt from your pension assets for two years,” she said.
Borrowing to pay for aged care makes sense if you can’t or don’t wish to sell your former home. The cost of this option, of course, is the interest rate charged by the lender. “The converse is if you pay a DAP to the aged care facility. The DAP is calculated on a government-set interest rate, currently 5.73 per cent. Borrowing to pay for aged care replaces the DAP with loan interest,” Whittaker said.