Home equity – the $500 billion resource for seniors

Reverse mortgages are an option for asset-rich, cash-poor seniors to boost their cash flow in retirement, but there are downsides.

The latest round of figures showing rising home values in almost all our state capitals highlights how many Australian retirees could have a valuable resource at their fingertips.

Older Australians, who may not have enjoyed the benefits of employer-paid super for their entire working life, can face the prospect of a lean retirement. However, one area where over-50s often have an advantage over their younger counterparts is home ownership.

ABS data shows that among the under-35s, there’s not much in it between the proportion of renters and those who own their home. Among the over-65s, almost 85% of people are homeowners. This is important because for senior Australians home equity can be a source of retirement income.

It’s all thanks to the availability of reverse mortgages – a financial product that allows homeowners, usually aged 60-plus, to draw on home equity with loan funds secured by their home.

No repayments are necessary with a reverse mortgage, at least while you live in the place. Interest charges and fees are added to the loan balance with the total to be repaid when the property is sold or the last borrower has passed away.

It’s an option for asset-rich, cash-poor seniors to boost retirement cash. But reverse mortgages do have downsides.

In its January 2017 star-rating report on reverse mortgages, research group Canstar found the average interest rate applicable to these loans is 6.25%. That’s around 2% more than you could pay on a standard home loan, and the mounting interest charge raises questions about how a reverse mortgage can impact home equity over time.

Let me start by saying that anyone considering a reverse mortgage should look for a ‘no negative equity’ guarantee. This means you will never owe more on the loan than the value of your home. That said, Canstar found that after 20 years, a loan for $90,000 representing 15% of a property’s value, could end up costing a total of $349,431 including the initial borrowing. Over 30 years, the loan cost including principal, could blow out to $662,131.

These figures may seem alarming, and they are based on current interest rates, which are at record lows. On the plus side, it’s a reasonable bet your property will rise in value over the next 20-30 years. The big unknown is whether the capital growth will outstrip the loan’s interest rate.

The latest review of the reverse mortgage market by Deloitte estimates Australians over age 65 hold more than $500 billion of home equity, yet only about 40,000 of the nation’s seniors have a reverse mortgage. So home equity is definitely an untapped resource. For retirees finding it tough to meet the cost of living, a reverse mortgage may be worth considering. Nonetheless, it is an area where good legal and financial advice is essential, especially if you plan to leave a reasonable estate.

 

Paul Clitheroe is a founding director of financial planning firm ipac, Chairman of the Australian Government Financial Literacy Board and chief commentator for Money Magazine.

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