Effie Za­hos

Re­tirees who plan to draw on the eq­uity in their home need to run the num­bers first

Money Magazine Australia - - CONTENTS -

How bad are re­verse mort­gages? Let me put it an­other way. How long would it take for your eq­uity to be com­pletely wiped out be­cause you bor­rowed money against your home.

While there’s no deny­ing that in the right cir­cum­stances re­verse mort­gages may be a good so­lu­tion for cash-strapped, as­set­rich re­tirees, there are many per­sonal and fam­ily con­sid­er­a­tions to take into ac­count be­fore mak­ing a de­ci­sion.

Un­like “for­ward mort­gages”, where prin­ci­pal and in­ter­est re­pay­ments re­duce the debt, re­verse mort­gages keep climb­ing.

They work like this: eq­uity in the home is con­verted into cash ei­ther through the pay­ment of a lump sum, a reg­u­lar in­come stream or a com­bi­na­tion of both.

How much you bor­row comes down to the value of your home and your age. Gen­er­ally, the older you are the more you can bor­row. Typ­i­cally, a 60-year-old is able to bor­row around 15%-20% of the value of their home and a 70-year-old around 25%30%. Min­i­mum and max­i­mum amounts ap­ply and they dif­fer among lenders.

No re­pay­ments are nec­es­sary. In­ter­est and fees are added to the debt and the to­tal is taken out of your es­tate.

The down­side? The com­pound­ing ef­fect of in­ter­est charges means the debt will usu­ally dou­ble ev­ery 10 years. At 8%, a $50,000 loan will be­come about $110,000. This im­pact could be re­duced if your lender al­lows you to draw down amounts as needed rather than tak­ing a lump sum up­front.

The upside? Prop­erty has his­tor­i­cally per­formed at 8%pa (gross) for the past 10 years. Bor­row­ers who are happy to as­sume long-term growth of around 3% (LVR of 20%) are likely to see the eq­uity in their prop­erty re­main the same. Of course, the more you bor­row as a per­cent­age of the value of your home, the greater the growth needed. Let’s say, for ex­am­ple, you’re a 70-year-old woman who owns a home val­ued at $600,000. You’re el­i­gi­ble for the full pen­sion but look­ing to top it up by $200 a month over the next 20 years. You’d also like $20,000 up­front to cover some much-needed home re­pairs and go on a lit­tle hol­i­day. You ap­ply for a re­verse mort­gage that costs $1000 up­front with a 6.5% vari­able in­ter­est rate.

Now the big ques­tion: how fast can you ex­pect your eq­uity to run out? The an­swer de­pends on three fac­tors:

• The fu­ture value of your home.

• How much you bor­row and when.

• In­ter­est and fees.

Ac­cord­ing to the ASIC Mon­eySmart re­verse mort­gage cal­cu­la­tor, house prices would need to grow by only 1.5% for you to still have more eq­uity in your home in 20 years than you do on day one. On day one you would have $580,000 in eq­uity ($600,000 less $20,000) and after 20 years, with 1.5% prop­erty price growth, you would have eq­uity of $633,243 (see graphic). Clearly, what you could do with $633,243 in 20 years isn’t go­ing to be as much but the eq­uity is still there.

Of course, if growth was 0% and in­ter­est rates jumped to 10%, the sce­nario would be a lot dif­fer­ent. Your eq­uity would drop right down to $294,000, mean­ing your ini­tial loan of $20,000 and $200 monthly pay­ments would to­tal over $305,000.

You can play around with the num­bers for your­self at mon­eysmart.gov.au.

Take care and get advice, es­pe­cially around your op­tions if you be­lieve you may need aged care. Dis­cuss the trans­ac­tion with Cen­tre­link to en­sure you fully un­der­stand the im­pact on any ben­e­fits.

While loans en­tered into from Septem­ber 2012 con­tain a pro­tec­tion clause that means you’ll never end up ow­ing the lender more than your home is worth, your kids may not get as big a div­i­dend cheque as they were ex­pect­ing.

The Aus­tralian Se­cu­ri­ties and In­vest­ments Commission is keep­ing a close eye on th­ese prod­ucts and is ex­pected to re­lease a re­port into re­verse mort­gages this month.

Fi­nance ex­pert and au­thor of The Great $20 Ad­ven­ture, Money’s edi­tor Effie Za­hos, ap­pears reg­u­larly on TV and ra­dio. She started her ca­reer in bank­ing.

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