Appearing on In The Black Digital site, October 2017
Reverse mortgages can be useful, but take care
“There is a significant number of retirees in Australia who are asset-rich, usually as owners of their house, but are cash-poor,” says Professor Louise Kloot, a consultant in the business education field and a key figure in the CPA Third Age Network, which focuses on retirement issues. “For these people, if they do not want to sell their house outright, a reverse mortgage can be a very useful tool. But reverse mortgages and equity releases have some traps and pitfalls, and it is the responsibility of accountants and financial advisers to understand them and explain them properly.”
In a recent a paper prepared by the Network, Professor Kloot explains that the most common form of reverse mortgage is a loan from a bank or other financial institution that allows the retiree to borrow money using the equity in their home as security. The loan is repaid when the home is sold, with the total amount including principal, accrued interest and fees. Most commonly, the loan is taken as a lump sum but there is also the option of a regular income stream or a line of credit.
A variation is an equity release, where a retiree sells a share of the house to a finance provider, calculated on a percentage basis. The retiree continues to live in the property rent free, and when the home is eventually sold the homeowner shares the funds with the finance company.
In many cases, the loan is used for improvements to the property, such as repairs or extensions. Loan providers require information on what the funds will be used for, and are generally very reluctant to provide the loan if the money is to be passed on to others, such as family members.
When reverse mortgages first appeared in Australia, in the 1990s, they were offered by most of the major financial institutions as well as many of the smaller ones. However, over the past ten years many institutions have moved out of the field, mainly due to the low interest-rate environment.
“The institutions currently offering reverse mortgages are Commonwealth Bank, the CBA subsidiary Bankwest, P&N Bank, and Heartland Seniors Finance,” says William McGregor, Senior Industry Analyst with IBISWorld, which has provided a research paper on the field. “The institutions that have provided reverse mortgages in the past have given commitments that the existing contracts will be honoured. But at the moment, and with reverse mortgages having a variable interest rate, there is simply not sufficient margin for them.”
According to the IBISWorld report, industry revenue declined at an annualised 4.9 per cent over the five years through 2016-17, to total $227.8 million. A further decline of 4.5 per cent is expected in the current year.
Professor Kloot notes that even those providers still in the market seem unwilling to advertise the product.
“There isn’t much in the way of brochures or information sheets,” she says. “You often have to go into the bank and inquire. But reverse mortgage products are occasionally mentioned in the personal finance sections of magazine and newspapers, so there is a continuing trickle of interest.”
Good advice needed
For people considering a reverse mortgage, Professor Kloot emphasises the need for independent financial advice.
“Because the payback date is often a long way off there can be a tendency to ignore the ongoing costs,” she notes. “The interest charges can build up over the life of the loan. So advisers have to carefully explain how compounding interest works, and ensure that the client understands it.”
There are also implications for Centrelink entitlements. This needs specialist advice as the consequences will depend on individual circumstances. Centrelink is likely to require supporting documentation about the loan as well.
From a regulatory perspective, reverse mortgages are considered to be a credit product by the Australian Securities and Investments Commission. On a few occasions, ASIC has required providers to change advertising to ensure that customers are properly informed.
Another regulatory move was legislation passed by the Commonwealth government in 2012 which stipulated that the maximum repayment is the market value of the property. This was meant to ensure that retirees could not be required to repay anything more than the sale proceeds of the house.
“That was a good safeguard,” says Professor Kloot, “but people looking at reverse mortgages and their advisers should note that it does not extend to things like real estate agent fees and other costs.”
Despite the pullback by many providers William McGregor believes that the reverse mortgage field will grow in the long term, as interest rates slowly rise and as the population ages. Industry revenue is forecast to increase at an annualised 3.4 per cent over the five years through 2021-22, to reach $269.8 million.
“Reverse mortgages have a role to play,” he says. “But they need careful consideration, an understanding of the implications, and an eye to the repayment date. It’s the sort of product that requires solid professional advice.”