The government has made it abundantly clear that retirees are expected to utilise their capital as they move into their final years. The big question is how to do that.
One option is to downsize to a cheaper home, but, as I pointed out in my book, Retirement Made Simple, this strategy often has the major disadvantage of converting an exempt asset — the family home — to an assessable asset. If you are receiving a part Age Pension now, increasing your assessable assets could severely reduce or even totally lose your pension.
To make matters worse, the costs of moving from one home to another are high, which usually means a net loss of capital. Most importantly, retirees want to remain in their local communities, and it may be hard to find a good-quality smaller home nearby.
One benefit of downsizing is that the government lets each homeowner put $300,000 of the proceeds of downsizing into their superannuation as a non-concessional contribution. But even that incentive has not convinced many older Australians to leave their family homes. Not downsizing obviously leaves many retirees asset rich, but cash poor.
This leaves two other options. Borrow against the home, or sell a portion of it using one of the equity-release options available. Today, I will discuss borrowing against the home. (I’m not going to talk about the equity-release options here – because they are somewhat complex and specialised advice should be taken by anyone thinking of using them.)
A conventional mortgage is not a practical option for most retirees. Being asset rich and cash poor, they cannot afford the recurring loan payments, and most have trouble getting a loan because of their age and lack of paid work.
However, there is a product designed for retirement called a reverse mortgage, for which no regular repayments of principal or interest are required. As a result, the loan increases your available income while you live in your home, but the debt also increases as time passes.
The 2012 the Australian Securities and Investments Commission (ASIC) consumer protections give borrowers with guaranteed lifetime occupancy of their homes, full responsible lending protections, and a “no negative equity” guarantee (which means you can’t ever owe more than the value of your home). ASIC also put in place conservative loan-to-value limits that increase based on the age of the borrower.
Josh Funder, CEO of Household Capital, explains how things have changed, “Home equity is our customers’ own money, their own wealth, and they use it wisely. On average, our customers use only half of the equity available to them, typically for two or three different long-term purposes. This meets their needs and also leaves more equity for their future and their kids”.
Common uses of reverse mortgages include:
More and more are now retiring with an outstanding balance on their home loan or credit card, and a reverse mortgage can refinance this debt without depleting retirement income. Another major use of home equity is to renovate the family home to enjoy another 20 years of a familiar lifestyle, and improve the value of a capital-gains-tax–exempt asset at the same time.
And finally, reverse mortgages are playing a big role in funding health-care costs — as well as both in-home care and residential aged care — which are woefully underfunded by the government.
The Centrelink PLS reverse mortgages are offered by the Australian Government to older Australians who wish to boost their retirement income by unlocking equity in their real estate assets. Through the PLS, people can receive additional regular fortnightly payments, which accrue as a debt secured against their Australian property. The PLS allows a fortnightly loan of up to 150 per cent of the maximum Age Pension, representing about $12,385 a year for singles and about $18,670 for couples, on top of receiving a full Age Pension. A compounding interest rate, currently 4.5 per cent, is charged.
The PLS is available to pensioners, part-pensioners and non-pensioners too. It’s delivered by Centrelink’s team of financial information services officers, who don’t have to provide all the consumer protections required by ASIC and responsible lending legislation. PLS reverse mortgage properties are revalued annually, and future drawdown availability is adjusted based on valuation, age and a range of other factors.
The Budget enhancements are expected to increase interest in the PLS, but it’s not a perfect product. It has the same issues as any other reverse mortgage: it compounds and reduces your capital. Remember that the essence of a reverse mortgage is that no interest or principal repayments are made on the loan, so it increases faster and faster.
Home equity is the largest store of lifetime savings for most Australians. If that’s true for you, don’t ignore it — understand your home equity and actively manage your access to it.
Like any other savings, the number one rule is “don’t blow it”! When you take out a reverse mortgage, you get to continue living in your home while spending your money, but that leaves less money for later, or for the beneficiaries of your will. So always use only what you need now, and always take into account your long-term future needs for funding, housing and aged care as well.
Ideally you can have an open conversation with the whole family to be able to meet your own living needs and understand the support you can give your family now, along the way, or as a bequest.
Reverse mortgages are flexible in that you can make voluntary payments of some or all of the loan at any time without fees or penalties, but it would be reasonable to expect that repayment will come from the eventual sale of the family home. If you or your family require access to capital but can pay the interest, you can do that to keep the loan amount from compounding. Overall, it’s usually best to draw down slowly on your home equity, as this slows the compounding effect and ensures you have some in reserve for future needs.
HOUSEHOLD CAPITAL INFO Important information. Applications for credit are subject to eligibility and lending criteria. Fees and charges are payable, and terms and conditions apply (available upon request). Household Capital Pty Limited is a credit representative (512757) of Mortgage Direct Pty Limited ACN 075 721 434, Australian Credit Licence 391876. HOUSEHOLD CAPITAL™, the Star Device and Household Capital and the Star Device are trademarks of Household Capital Pty Ltd.
IMPORTANT LEGAL INFO This article is of a general nature and FYI only, because it doesn’t take into account your financial or legal situation, objectives or needs. That means it’s not financial product or legal advice and shouldn’t be relied upon as if it is. Before making a financial or legal decision, you should work out if the info is appropriate for your situation and get independent, licensed financial services or legal advice.
Whether your home needs reroofing, your mortgage needs refinancing or your teeth need recapping, your home equity can renew your retirement and help you enjoy the lifestyle you deserve. Try our easy-to-use calculator to see how much home equity you could access.