We all face an uncertain future as our nation gets older. More than half of all Australians will be over 50 by mid-century. Young or old, we’re all in it together.
The government is in a race against time to fix the ballooning costs of aged care. By 2055, the AU$42 billion being spent on pensions will grow to a barely believable AU$160 billion. Almost 80% of people of retirement age today expect to still be receiving their pensions in 2055. That’s going to put enormous pressure on the rest of the economy.
Slashing spending and higher taxes will be high on the list of priorities for those in office. But the longer the government puts off pension reform, the harder it’ll be to change. Half the electorate will be on aged pensions by 2055. Pensions will be untouchable if nothing’s done before then.
The latest idea to ease the pressure on the budget is to reform reverse mortgages. Reverse mortgages allow people to use the value of their home to create a new source of income. In other words the bank gives you money to take an increasing stake in your home. It’s not exactly a novel scheme, but very few retirees use reverse mortgages in retirement.
The plan involves unlocking up to an existing AU$625 billion in home equities. To do this the government wants to include family homes in asset tests. That could make you ineligible for a pension if you own a house. The government hopes that would increase the take up rate for reverse mortgages. Your assets are more valuable, so you get less in pension income.
The government already offers reverse mortgages through their Pension Loans Scheme (PLS). But it’s a blip in the ocean compared to the AU$625 billion they want to open up to reverse mortgages. In 2014 the PLS made loans totalling AU$31.9 million. The PLS currently allows you to borrow up to 45% of the value of your home. Under a new scheme, borrowers could access up to 80% of their home value. And they’d also receive a government guarantee that they’d never be forced out of their home.
So you can see how they want the plan to work. Aussie pensioners use their home to access cash, and lose their right to the age pension. Sound fair?
If you think this idea is an attack on pensioners, then you’d be right. The government may sugar coat it by telling you your living standards would improve.
But here’s the thing. And I’m going against what I believe. Wealthy Australians are entitled to their wealth. You’ve earned it. But if we can find ways to take some of the pressure of aged care costs, I believe it’s something worth pursuing. I think we’d all agree that Australians doing it tough in retirement need all the help they can get.
Right now three in four Australian retirees own their homes. Opening up reverse mortgages could help the entire nation avoid crippling debt in the future.
Bu reverse mortgages can be risky. And they’re not for everyone. Here are some brief guidelines that may help you decide whether it’s for you.
How exactly does a reserve mortgage work?
A reverse mortgage simply allows you to borrow money against the equity of your home. Let’s say your home is worth AU$500,000. You could borrow up to AU$225,00 under the governments PLS. Currently reserve mortgages are offered to people 60 and over. And the amount people can borrow goes up the older they are.
What this means is that you can use your home (minus whatever you still owe on it) to receive a lump sum payment straight away or as a steady stream of income. A reverse mortgage could help you manage your money more effectively during your retirement. You may find that superannuation doesn’t take you far enough in retirement. This is one way to receive a steady income using your home.
But the big attraction for many is that you still get to live at home. While interest gets charged on your loan, you don’t have to make any repayments. Not until you leave or sell your home. Instead, the interest builds up over time and it gets added to your loan balance. That leaves you as the owner-occupier of your home. You can stay there until you decide otherwise.
One of the reasons that reverse mortgages have failed to gain traction is because people are afraid of banks evicting them. That’d leave your children with nothing to inherit. Where a looser government backed reverse mortgage scheme could help is to provide stability when interest rates are lower and cash savings aren’t generating an income. But that’d still leave you with a large loan to pay off.
To reduce the risks of this, the government introduced negative equity protection in 2012 for every new reserve mortgage contract. It was designed to prevent people owing the lender more than the equity on their home (what their home was worth).
That means you — or your children — aren’t liable for any debt in excess of the proceeds of the sale. If your home sells for more than what you own the lender on your reverse mortgage, you will receive the extra funds.
What are the borrowing limits for a reverse mortgage?
Lenders have different requirements for how they calculate loan terms. But a general rule of thumb is that the older you are, the bigger the loan you’ll be able to take out. For example, if you’re 60 years old, most private lenders will let you borrow anywhere up to 20%.
If you paid off a AU$500,000 home, you would be able to borrow as much as AU$100,000. If you’re older, you could be entitled to even more. The government scheme currently allows homeowners to borrow up to half of the value of their home. Private banks lend up to 30% of the value of the property now, but they could follow the government’s lead if homes were used in the age pension eligibility test.
But it’s also important to know that you can max out your borrowing limit. If you borrowed the maximum amount allowed, based on the value of your home, that could exclude you from any further loans in the future.
How much does a reverse mortgage cost to take out?
With compounding interest, the loan can quickly grow to become a sizeable chunk on your balance sheet.
The costs you’ll be liable to pay are dependent on the terms of the loan. That means the amount you’re borrowing will decide how much it’ll cost you. That includes the interest and any other additional fees.
Let’s say that you took out a AU$100,000 reverse mortgage loan, charged at a variable interest rate of 7%. And let’s say you were 60 years when you did this.
Every year, you would pay 10% of the existing loan amount, which in the first month would be AU$7,000. The new balance after one month would be AU$107,000. The following month, the interest on that loan would be AU$7,490. Compounding interest uses the new balance to calculate the next interest charge. You can see how that loan balance can grow quickly over time.
Why a reverse mortgage may not be for you
If you’re considering taking out a reverse mortgage, it pays to know the risks you face.
For one, the loan must be repaid in full when you sell your home. That includes the interest that has built up over time. And in the event of your death, that loan would still need to be repaid. Whoever inherits the home would need to cover the loan. But they’d also be able to use the left over value from the property. This could be used to repay the loan, or to purchase another home. It just depends on how much its residual value is.
The interest rates for reverse mortgages tend to be higher than regular home loans. Variable rates from many lenders hover around 7%. That’s compared to a normal home loan which you can get at closer to 4%. The same applies for comparison rates. A home loan comparison rate of 5% can come in as high as 7% for reverse mortgages.
Added to this is the fact that interest for reverse mortgages is compounding, which I’ve already touched on. Fixing the interest rate can lead to hefty penalties if you decide to break the agreement on the loan.
As I’ve already discussed, the biggest threat might be to your pension. If your home disqualifies you from the pension (or reduces the pension amount), it can hurt your retirement. The current pension test doesn’t include your principal home in assessing your eligibility. If the government changes this, you may need to weigh up whether it makes more sense to receive your existing pension or to reverse your mortgage.
Contributor, The Daily Reckoning
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