Ageing population calls for more reverse mortgages 58



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By Harry Scheule, University of Technology, Sydney


Reverse mortgages are a way to release the equity in a home, which is an important component of wealth for many Australians.

Such mortgages have been proposed by the Financial System Inquiry as a way to support the dissipation of wealth by retirees and boost the efficiency of Australia’s financial system.

The following chart shows the stark increase in mortgage lending by Australian banks since the global financial crisis (GFC). Australian banks hold approximately A$1.3 trillion in mortgages.

Mortgage loans provided by Australian banks (Authorised deposit-taking Institutions)
Australian Prudential Regulation Authority

Reverse mortgages have matched this growth in relative terms but remain at the margin, with a total exposure of A$2.9 billion (see the line at the bottom of the chart), far below standard mortgages and higher risk loans such as interest-only and low-documentation loans. Despite this growth in volume, the number of lenders has shrunk over time. According to the Financial System Inquiry, more than 15 lenders existed before the GFC but just five remain today.

Why are mortgages so popular and reverse mortgages not so, despite an ageing population with many billions of home equity waiting to be released?


How reverse mortgages work

A reverse mortgage allows homeowners to access a lump sum or an annuity, using their home as collateral. The benefit of reverse mortgages is that borrowers often continue to live in the property until they die. The decision to sell a house is often an emotional one and can be avoided with this product because the loan may be repaid from the sale of the house after death.

Reverse mortgages may also be used to fund outgoings or, in aged care, accommodation bonds that are typically in the hundreds of thousands of dollars.

Alternatives exist: Australians who wish to access home equity often prefer to sell the home and buy or rent a smaller one. This decision may trigger costs such as capital taxes and other fees but may also have merits, as retirees move into a home of the space and standard they require. Free cash may then be converted into annuities, funding a monthly income for instance.


How does a reverse mortgage differ from a standard mortgage?

In a reverse mortgage, the loan amount increases over time, up to a limit, as the borrower draws on the line of credit. The loan amount grows further as interest is added to the outstanding sum. As borrowers often have limited other assets and income with which to repay the loan, and if they enjoy a long life, the loan amount can quickly compound to unexpected levels.

To protect consumers (covered by the National Consumer Credit Protection Act), legal and financial advice via standardised calculators must be provided to customers for these products. In addition, banks provide a “no negative equity” guarantee, which means the loan amount cannot exceed the property’s value.

Finally, interest rates are generally higher than for standard home loan products due to less competition in this sector and higher risks for the lender. In this part of the market lenders tend to provide no more than 50% of a property’s value while standard mortgages tend to be around 80% of value – higher if mortgage insurance is used.


What are the risks for lenders?

The no negative equity guarantee may result in losses if loan amounts exceed property values. Despite generous collateral buffers, this can happen in a number of ways. First, home prices may fall. It is not unreasonable in financial markets to see drops equivalent to prior rises.

In addition, home owners have a right to live in the property and repayment occurs only after death. If a borrower enjoys a long life after taking out a reverse mortgage, or if the loan amount accrues at a higher rate than house prices the lender can be caught by the no-negative-equity guarantee. Longevity risk is very difficult to assess as it requires predicting life expectancy.

Longevity risk is also subject to adverse selection. Unlike in life insurance, it is healthy consumers who are likely to be keen on reverse mortgages.

In addition, the limited number of reverse mortgages makes it difficult for banks to do their risk analysis. Lenders condition the loan amount on the age of borrowers (the older, the larger the possible loan amount).

Borrowers also have prepayment options and may refinance and prepay a reverse mortgage if they find a cheaper lender, exposing the original lender to further risk.

Another aspect is that once the negative equity threshold is reached the borrower has no further financial incentive to maintain the property, which could result in a further depreciation of the property value.


How to promote home equity release

Home equity release is positive for the efficiency of the Australian economy and in line with our concept of retirement. In the US the government provides no-negative-equity guarantees to take some risk off the lenders and support this market.

The Australian government might not be prepared to indemnify the industry for risk. However, the development of such markets could be supported with more general measures.

Firstly, homes may be further recognised in the means test that determines the age pension. Such a measure may better match the needs of the population.

Secondly, a big industry concern is the limited availability of risk transfer solutions, such as derivatives and securitisation structures, which would allow banks to reduce both house price risk and longevity risk, at reasonable cost. It is difficult for banks to hedge or transfer longevity and house price risk. This is something of a catch-22 for the sector – only more equity release may lead to more risk transfer solutions and vice-versa.

The Conversation

This article was originally published on The Conversation.
Read the original article.

Harry Scheule

Associate Professor, Finance, UTS Business School at University of Technology, Sydney

  1. Because reverse mortgages are a sure fired way to make sure you get no pension and your kids no inheritance. It’s a lose, lose for you and your kids, and a whopping great win for the government.

    5 REPLY
    • Kids don’t get inheritance in lot of cases now. Cos aged care facilities make you sell to pay up front for your care

    • I am NOT going to reverser mortgage. I dont have one now and dont intend to get one in the future. I can live cheap if I have too or sell the home and live with the kids in a granny flat out back.

    • What a load of absolute rubbish. Reverse mortgage will only allow you to take out a maximin of 20% of the value of the house. The capital gain on the property is always greater than the interest paid on the money. So the value of the house upon your death will still be 80% GOPING TO the inheritance and 20% back to the bank.

      Don’t make up numbers just to embellish your argument.

    • Joe, This was posted by Trevor, I Investigated a reverse mortgage with Australian Seniors Finance, because we were both at a relatively young age (under 70), the maximum we could realise on a home worth $245,000 was $39,000. They amount is set so that it is impossible to go into negative equity, so the younger you are the less is available. The compound interest on that amount meant that if we reached our nineties the entire property would belong to the finance company.. We are giving that one a miss.
      Equity release is a different kettle of fish. There is no negative equity problem with that as the amount realised is around 50 -60% of the property value but the interest must be paid each month, so the principle never increases over the credit limit. The interest is around 6-7% at the moment but is variable so that must be taken into account. A much better option but so far the only good one I have found is with ANZ and they will only offer it to existing customers, which I am not. We are still looking for something similar with other banks.

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  3. Insurance companies and banks rubbing their hands with glee at the thought of selling more rubbish annuities!

  4. I’ve read stories about this in the UK. If the company that reverse mortgages your home goes bankrupt – you lose everything. You notice the article specifically mentions that the government doesn’t offer any protection on reverse mortgages.
    Basically – a bad idea.

  5. No way, it’s the kids inheritance.

    3 REPLY
    • so heather inglis you are happy for the taxpayer to support you so your kids can get your house ..perhaps its time to bring back death duties …???

    • Graeme Condely, If you have worked your bums off like we have and own your house plus an investment property– yes we will leave it to our children. We are self funded retirees and need to answer to no-one. We have earned everything through very hard work.

    • well said Christine O’Shea , its interesting how many are quick to judge and they forget that while you were working and accumulating you paid taxes that now support others, and your not whinging about that, yet others begrudge anything you want to give your family that you well and truly paid for. wish you a wonderful life.

  6. I agree with all of the previous comments. Just what I was thinking before I even read them. It would be the people who have been frugal all their lives being punished and the people who have nothing because they wasted all their money would end up the winners.

  7. No way – when I retired I never paid my mortgage out completely but left a small amount owing to ensure that I always had access to the redraw facility. That enables me if needed to borrow a small amount to do running repairs or replace things but I then have to continue on with loan repayments – for amounts of less than $20000 that is a manageable option even on a pension I find.

    4 REPLY
    • Great idea Maureen, I don’t know why more don’t do this to enable a few luxuries rather than live like paupers to ensure the kids get the house.

    • That’s what we do and will keep doing. Just don’t pay out the mortgage. It’s very handy and it’s not actually money in the bank so won’t affect pensions.

    • You can pay it out but not close it off. That way you have access to the excess amount you’ve paid and still get a free credit card, no bank fees or whatever your bank offers but you don’t have mortgage repayments on a pension.

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