Reversal of fortune: Why equity release makes sense
Low interest rates and high house prices are prompting more retirees to take out a reverse mortgage. These loans – primarily offered in New Zealand by Heartland Bank – allow homeowners to borrow a sum of money against their property. They do not have to make any repayments until the house is sold. But interest accrues and compounds, so the amount that finally falls due can be a lot bigger than what was borrowed.
Heartland head of retail Andrew Ford said his organisation had seen a big jump in inquiries since interest rates fell.
In the half-year ended December 2019, the Heartland Bank reverse mortgage business increased 10 per cent to $536 million in lending. Inquiries were up 39 per cent in the last quarter of last year compared to the year before.
Ford said downsizing had traditionally been the only way that people could access money tied up in a house but reverse mortgages could take the stress out of everyday bills or even fund travel.
But it’s not a straightforward decision. Here are five things to think about first.
Size of the loan
Ford said the average amount borrowed was $50,000 and that was typically 10 per cent of the value of a borrower’s home.
People could also opt to have an ongoing stream of income or a line of credit open if they needed it.
Interest is charged by Heartland at a variable rate, currently 6.95 per cent a year. A $5000 loan would double in 10 years if no payments were made.
Ford said most people held a loan for six or seven years. At the end of that time, the loan was usually equal to about 25 per cent of the value of the house at the point the money was borrowed.
Getting advice
Legal advice is required for a reverse mortgage but it’s also worth getting independent financial advice.
Tom Hartmann, editor of Sorted, said: ‘‘You do run into the richest poor people out there who are asset-rich but cash-poor.’’
He could understand why the product appealed when house prices seemed only to be moving up. ‘‘That ends up making reverse mortgages look much better than they are. In general you end up losing a substantial portion of your house’s equity.’’
Family views
A reverse mortgage will usually mean that there is less equity left to pass on to future generations.
Whether that bothers you or not, it’s probably worth telling anyone who might expect an inheritance.
But financial commentator Janine Starks said people should not worry too much what their children thought.
‘‘There is the assumption that lawyers need to check the retirees’ brain cells to make sure they understand the full implications of their decision, because it will punish their family by lowering inheritance levels.
‘‘In reality these people have spent their whole lives paying off a mortgage through many turbulent times in our economic history.’’
Families did not understand the psychological impact of moving home late in life. ‘‘Everyone thinks their parents will simply downsize but many leave it too late.’’
Other options
Ford said it would make no sense for people to take out a reverse mortgage if they had better options, such as money in the bank.
But for some people, ‘‘they can make a transformational difference’’.
Ford said people were unfairly negative about reverse mortgages. ‘‘If you were sitting on a $1 million home and wanted a reverse mortgage to do some things, some might say you shouldn’t because the loan will grow over time. But the same person in a $500,000 home with $500,000 in the bank wanting to spend $50,000 – people would say ‘treat yourself, you’ve earned it’.’’
Hartmann said a reverse mortgage should be a last resort.
Plan for change
Ford said Heartland often dealt with people who only wanted a loan for a short time, or who planned to stay in the house forever – but plans could change quickly.
Prospective borrowers needed to consider the possibility of the unexpected. ‘‘Flexibility is really important.’’
Starks said there was a historical bias against equity release products.
‘‘Financial advisers, bankers, lawyers and accountants are preprogrammed to approach the product like it carries a disease.
‘‘All this does is create shame rather than support around a product that has incredible benefits for homeowners who want to enhance their lifestyle or genuinely have no other method of tapping into a large asset.’’
The process was loaded with so many warnings that getting through it required a thick skin.