How a reverse mortgage can ease the squeeze in later years

Anna Balzamo is coming out of one of the toughest periods of her life.

At the end of last year she lost her husband to cancer. Then, his adult children contested the will and Anna's daughter's relationship ended.

Balzamo, 61, works in reception at a major Sydney hospital. She took out a reverse mortgage about six weeks ago to repay debts and help out her daughter.

"I was sceptical initially as you hear on current affairs shows about these people who come and take their homes," Balzamo says.

"It's made a huge impact on my life already. It has given me peace of mind and I can sleep at night; not having to worry about how to pay the bills."

Many retirees are asset-rich and cash-poor and look to reverse mortgages to provide funds for living expenses or aged care.

How it works

Reverse mortgages are usually available to those aged at least 60 who own their house outright.

The money is borrowed with the house as security. No repayments on the loans are made until you die or sell the house. As a result the interest is capitalised and the loan size increases - and you pay interest on any fees and charges that are added to the loan balance.

During the global financial crisis those on relatively high fixed interest rates tried to refinance to lower variable interest rates and faced substantial break fees.

In 2012, the government brought in laws to better protect borrowers.

One of those rules is that reverse mortgages must have "no negative equity" guarantees, where, if the house is sold and the amount owed exceeds the sale proceeds, the lender wears the loss.

There are also guidelines on the maximum loan-to-valuation ratio (LVR). For example, where the youngest person (of a couple) is 60, the maximum LVR is 20 per cent. The older you are, the higher the maximum LVR - at age 70 it's 30 per cent.

Limited choice

But while a reverse mortgage may stack up for some, there are fewer providers to choose from after Westpac pulled out of the market earlier this year.

The Australian Prudential Regulation Authority is enforcing higher capital buffers, particularly against interest-only investment property loans.

As reverse mortgages are a form of interest-only loan, since no principal is repaid until the house is sold, that means for some lenders reverse mortgages have become uneconomic.

CBA (and its subsidiary Bankwest) is the only one of the major banks offering reverse mortgages. There are a handful of smaller players - you can find them by searching on a site such as Canstar.

After the earlier problems with fixed rate reverse mortgages, lenders only offer variable interest rates, which tend to be about 1.5 percentage points above standard variable mortgage rates.

Alternatives

There's also an alternative product called an equity release scheme - the main one is Bendigo Bank's Homesafe Wealth Release.

Bendigo takes a fixed equity stake in the home - the bank's share does not rise over time in percentage terms, but the bank benefits from any rise in the property's value.

Homesafe is limited to Sydney and Melbourne, and certain postcodes within that, and excludes most apartments. It's available to people over the age of 60 - though in NSW one partner in a couple can be as young as 55.

Consumer group Choice produced a report last year on reverse mortgages and equity release schemes in which it pointed out that with equity release schemes the homeowner can lose a "big chunk of the ultimate value of the part of your home you sold to the home reversion scheme provider" because of rising property values.

There's also a government version of a reverse mortgage. Centrelink and the Department of Veterans' Affairs have a Pension Loan Scheme, where those on a part pension can take out a loan against a property that is repaid when the property is sold.

However, the Pension Loan Scheme loans can only be taken as an income stream and it's limited to that which takes them to the maximum age pension. Those drawing the maximum pension are not eligible.

Subject to conditions, it is available to some retirees of pension age who are not receiving the pension. The interest rate is 5.25 per cent, about 1.25 percentage points less than for reverse mortgages.

Lump sum

Many people like to take a reverse mortgage in a lump sum so they can do repairs and renovations on the house, says Martin Lynch, head of reverse mortgages at IMB Bank.

"They will often have a credit facility, where the money is drawn down as needed," Lynch says.

"The reality is that retirees really appreciate it and now we have more people using it for aged care as well and that's pushing demand."

Lynch is referring to the refundable accommodation deposit (RAD), which can be more than $500,000 in Sydney and Melbourne.

Balzamo's adviser was Ambreen Sumar, a reverse mortgage and aged care lending specialist at Omniwealth. She says a typical scenario is that the remaining parent needs to go into aged care and the children don't want to sell the house to the pay for the bond.

"Often, it's a family decision and it can be an emotional decision to sell the family home," Sumar says.

Several reverse mortgage providers allow the house to be rented out and it gives the family time to decide on the next move with the possibility of further appreciation in the value of the house over time, she adds.

Caution needed

Mark Borg, a senior financial planner with AMP Financial Planning, says reverse mortgages have a place.

"But you have to be conservative in how you go about it," he says. You need to make sure that there is going to be enough equity left in the house to be able to cover the costs of aged care, Borg says.

Borg adds that a reverse mortgage could negatively impact Centrelink benefits such as the age pension. But he says it can be better than downsizing the house.

Downsizing the house incurs sizeable transaction costs - especially if the retirees try a sea change and then change their minds - and means you forgo growth in the property's value.

Wayne Leggett, a financial planner with Paramount Wealth Management, likes reverse mortgages but says it's important to understand their implications.

Borrowers have to understand they will be left with less money when they go into aged care or a retirement village, and there'll also be less for their heirs when they die.

It is a requirement of a reverse mortgage that the borrower gets legal advice on the contract. Leggett recommends getting independent financial advice as well, to consider other options.

A close look at the numbers

ASIC's reverse mortgage calculator shows how much the home owner or the beneficiaries of the estate stand to lose to the reverse mortgage lender when the property is sold.

Assume a house value of $1 million with both owners aged 60, who take $200,000 as a lump sum.

Typically, reverse mortgage interest rates are about 6.5 per cent, establishment cost is about $1000 and ongoing fees are about $10 a month.

The calculator shows in 10 years' time, the lender would be due almost 30 per cent of the sale proceeds if the house were sold. The surviving partner would have no equity in the house once they reached 100.

However, tweaking a few of the assumptions changes the outcome.

Let's assume interest rates rise and swap the 6.5 per cent interest rate for 8.5 per cent. Let's also reduce the assumed annual increase in the property value from 3 per cent a year to 2 per cent.

In 10 years' time, if the house were sold, almost 40 per cent of the proceeds would go to the lender. The owners or surviving owner would have no equity in the house by age 85.

This story How a reverse mortgage can ease the squeeze in later years first appeared on The Sydney Morning Herald.