Take care with reverse mortgages
Reverse mortgages, otherwise known as equity release loans, have been tipped as a product of the future for a long time.
With an ageing population of cash-strapped house-owners, the argument goes that lenders willing to hold off receiving interest for a few years have a ready market to tap.
The boom hasn’t happened yet but Heartland Bank is doing its best to give it a push along with a TV advertising campaign.
Readers, prompted by my last two columns on retirement villages, have asked me to outline how these loans work.
In short, they are loans secured against the equity in a home, available to people over the age of 65.
They place a lump sum in the hands of the borrower they can use for anything.
It’s like freeing a chunk of equity from the home, hence the name ‘‘equity release’’.
No repayments have to be made until the home is sold and when that happens it is left to the owner.
That allows people to do things they could otherwise not afford, such as repairing a leaking roof, replacing a car or bringing forward an operation, things that can mean the difference between an older person having to go without, suffering in silence and losing their dignity and quality of life.
Key protections include Heartland promising homeowners will never end up owing more than the value of their home.
The fees are high, including a $1195 arrangement fee, and interest is higher than an ordinary mortgage.
And as there are no repayments until the house is sold, the amount owed compounds, so over time these loans progressively transfer equity from a householder to the lender, hence the name ‘‘reverse mortgage’’.
At the time of writing, Heartland was charging 7.85 per cent, and it is a variable rate, so it can rise or fall, though Heartland says it aims to keep it at 1.5 to 2 per cent over the major banks’ variable mortgage lending rates. In times when house prices shoot up, reverse mortgages are easier to buy but as Gareth Morgan in his book Pension Panic warned: ‘‘These products have the potential to cruelly destroy the asset base of the aged unwary.
‘‘We occasionally enjoy a run where interest rates are low and property values are rising; under these circumstances, reverse mortgages look pretty good.
‘‘But we also have phases where interest rates are high and property values are flat or deflating.’’
Heartland has an honest calculator on its website so potential borrowers can play about with interest rates and expected house price growth to see what would happen to their equity in various scenarios.
The standard interest assumed by the calculator is 8.85 per cent, higher than its current rate, and we’ll assume that’s roughly the long term average Heartland thinks likely.
At 3 per cent house price growth, a loan of $50,000 and a house worth $500,000, the amount a borrower would owe after 10 years would be just over $120,000 and equity left would be around $549,000.
Drop the growth rate to 1.5 per cent and equity remaining would be $458,000.
Drop it to zero and the equity would be around $378,000.
And of course $1 in 10 years’ time is worth less than $1 now. Such large changes from such small variations in the inputs to the calculator show these are very serious loans.
Take time to understand them. Explore other options first.