We’re living longer and healthier lives but at times the public debate around longevity almost seems to suggest this is a problem, rather than good news! The issue that arises is so we can look forward to enjoying them?
There is, quite appropriately, a lot of focus on the Age Pension and superannuation. But there are other options, including the potential to use the equity in our homes to help fund retirement needs, such as through a reverse mortgage.
After all, we live in a country where the considerable majority of older Australians are fortunate enough to own their own homes. Furthermore, rising house prices have typically increased the value over time, so the home is very often our largest (financial) asset.
However, as the School of Risk and Actuarial Studies at the University of New South Wales recently noted, “schemes that allow people to unlock their housing assets … should be far more popular than they are.”
Why has there been less take-up of home equity release products to boost retirement funding? One reason is that such products have been perceived as potentially dangerous, and taking advantage of older borrowers. In the past, these products were arguably designed and sold in a way that was not in the interests of borrowers, with a focus on short-term consumption needs and little consideration of longer-term risks, such as negative equity. The perception was that this was a market with few protections and a ‘wild west’ element.
This may have been the case at times, but the law now contains important safeguards. Many are not aware that the consumer protections in place for reverse mortgage products today are much improved, and the Australian rules compare very well internationally.
This doesn’t mean that there are no risks, but if you are considering the pros and cons of accessing your home equity via a reverse mortgage, it’s important to understand what protections are in place so that you can make a well-informed decision.
To be clear, my aim is not to suggest you should take out a reverse mortgage. You need to carefully weigh up that decision yourself, with information and advice from trustworthy sources. Rather, in making that decision, it makes good sense to understand the protections you have and what risks they cover. So, what are some of these rules?
A key protection is the ‘no negative equity guarantee’, which has been in place since 2012. What does this do? It means that borrowers cannot owe more to the lender than the market value of their home when it is sold. The reverse mortgage in this sense is effectively a ‘non-recourse’ loan. This means lenders must pay back any amount paid by the borrower that exceeds the property’s market value.
Furthermore, borrowers can remain in their home until they pass away or decide to move out. You have, in effect, lifetime occupancy of your home. What’s more, you don’t have to make regular repayments and therefore can’t be evicted for missing a repayment.
The law also protects borrowers by requiring a conservative approach to lending. It does so by limiting the size of the loan that can be offered through controls over the loan to valuation ratio (LVR).
The maximum LVR will depend on the age at which the borrower takes out a reverse mortgage. For example, at age 60 you can be given a loan that represents 15 per cent of the agreed value of the home. This helps reduce the long-term risks of inappropriately large loans.
Of course, this means that the value of your equity will decline over time. But for most borrowers in most economic scenarios, a retiree accessing their available home equity at 65 will still retain significant home equity at age 90. This means they can fund a longer life, meet their aged care needs and make a bequest.
Having said this, the potential impact on your home equity over time is something you should certainly understand before committing. Interestingly, this is also required by law. Lenders must give borrowers information about the potential future impacts on their home equity taken from the reverse mortgage calculator on the Australian government’s Moneysmart website. In other words, there’s an independent calculator that helps borrowers understand future risks. Lenders must also ask about the future needs of the borrower, including aged care.
These are some of the main examples of protections designed specifically for reverse mortgages, but not necessarily for other forms of home equity access. In addition, there are also more general consumer protection laws in place.
For example, home equity contracts are also covered by laws that prohibit unfair contract terms, where the rights of the borrower are out of balance with the rights of the lender. The Australian Securities and Investments Commission (ASIC) conducted a review of the terms in reverse mortgage products a few years ago and worked with the industry to remove certain terms, especially where problems may have arisen due to inadvertent minor errors by the borrower that really had little impact on credit risk.
Furthermore, providers of these products are required to belong to the Australian Financial Complaints Authority, a complaints resolution service that is free to borrowers should any disputes arise.
It’s important that there are these protections in the law for seniors accessing their home equity via a reverse mortgage. After all, these are not simple products and they can be long term. There are still risks with any form of home equity access, which any potential borrower needs to think about carefully. Anyone looking to use such a loan should visit the Moneysmart website or consider seeking financial advice. In doing so, it’s in your interest to also ask about these protections, how they work and what they mean for you.
There’s been a lot of effort put into improving protections for seniors seeking to add home equity to their retirement funding. The consumer protection rules help deal with some of the potential concerns that can arise. These rules don’t remove all risks, but they certainly support the aim of providing equity release products to fund retirees’ needs in a responsible and sustainable way.
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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.
Now that you know more about the ‘modern’ reverse mortgage, how could your home equity improve your retirement lifestyle? To see how much equity you could potentially access, try our easy-to-use calculator.