Reverse Mortgages - House warnings - Article reproduced from the Sydney Morning Herald

Life used to be so simple. You left school, got a job, found a partner, bought a house, raised a family, retired, then quietly died within a year or two.

No more. Advances in medical science mean we are now living much longer than we used to. In fact, those who were born between 1900 and 1910 could expect to live only until 57, whereas those who are born today can look forward to life beyond 80. Put another way, that's an additional 15-odd years after retirement without a full-time wage.

Financing an adequate retirement is not just an issue confronting baby boomers and their parents. As life expectancy is pushed further over the horizon, generations X and Y also need to develop financial strategies for retirement. But they have an advantage over the boomers - a working lifetime of superannuation.

According to the Australian Bureau of Statistics, the number of people over 65 will jump from 2.3 million in 1999 to between 6.2 million and 7.9 million in 2051, or from 12 per cent of the population to about 26 per cent.

Perhaps more worryingly, a recent report by the Australian National University suggests these figures seriously underestimate our life expectancy.

The report, by Heather Booth and Leonie Tickle, found that 52 per cent of today's female baby boomers aged 50, and 34 per cent of men the same age, will live until 90.

"Though the prospect of a lengthy life may be welcomed by individuals as an opportunity to achieve outstanding life goals," the report says, "it also points to the need for serious consideration of plans for financial security in old age.

"Research shows that people who are retiring now are unprepared for how long they are going to live and what they are going to need."

David Deans, the chief executive of COTA National Seniors, says there are only a limited number of options for funding a retirement, all of which should be discussed with family members, financial planners and, in some cases, lawyers.

These include downsizing the home, borrowing from family members or even the Government (see box), re-organising your expenses and budgeting, returning to the workforce, or taking out a loan against the equity in the home, known as a reverse mortgage or a home equity conversion loan.

FAMILY JEWEL

A KPMG demographer Bernard Salt says many older Australians have one ace up their sleeves - the family home.

"These people would have bought a suburban property in the 1950s and '60s for a couple of thousand dollars and have been swept along with the rising tide of property values. You cannot have bought in Melbourne or Sydney in the 1950s and '60s and not be asset-rich."

ABS says about three-quarters of those aged over 60 are home owners. By age 65, 64 per cent own their own home outright, and by 75 this jumps to 80 per cent. Or put another way, there is a combined $450 billion tied up in the home equity of senior Australians, creating a very lucrative market for financial institutions.

Australian lenders are now catching up to their overseas brethren in offering senior Australians a way to unlock this value without selling the home.

Reverse mortgages operate the opposite way to a home loan. Instead of the loan amount reducing as repayments are made, interest is applied to your loan, which is secured against the house. No repayments are needed until the borrower dies or permanently moves out, with the total amount growing over time. That means the lender could end up owning a large part of your house - or, in the worst case, all of it.

"Reverse mortgages are definitely on the table [as an option to fund retirement]," says Denis Orrock, general manager of bank monitor InfoChoice. "All the banks have identified them [as] potential wealth-management income. Currently they are a little bit expensive, but the price will come down with competition."

MIS-SELLING

Reverse mortgages were first sold in the UK in the 1980s, as interest rates were rising and property prices falling. The result was misery and financial destitution for thousands of elderly, who were evicted from their homes as the loan amount exceeded the home's value.

To head off similar problems in Australia, four lenders targeting this market have formed a self-regulatory body to give the industry greater legitimacy.

The members of SEQUAL are St George Bank, Australian Seniors Finance, Bluestone Equity Release and OFM Investment Group (formerly Over 50s Mutual). The Commonwealth Bank, which offers a reverse mortgage, is not a member.

All members of the voluntary organisation must adhere to two key standards: that borrowers get independent legal advice - separate to the sales process - and there is a "no negative equity" guarantee. That is, if the value of the loan grows to more than the resale price of the home, the borrower won't be ejected while they are still alive.

SEQUAL's convener, Alison Bentley, says the lenders have done their own risk analysis and maintain they have the balance sheet strength to support these loans should the bottom fall out of the property market, or interest rates soar.

She dismisses suggestions that the UK experience could happen here, arguing that Australia has much tougher regulations and market conditions here are markedly different.

"Our code sets up a strict standard by which SEQUAL members and their distributors market and promote this category of product," she says.

"All members must have a non-recourse product so the customer or their estate can't be asked to meet the loan if it exceeds the value of the property."

Still, potential borrowers should read the loan document. The Commonwealth Bank publicly declares that it has a "no negative equity" guarantee on its reverse mortgage but fails to mention it in its loan document.

A CBA spokesman said it was irrelevant whether the loan contract specifically mentioned the bank's guarantee.

"As we have the no negative equity clause in our brochure, should we not adhere to this statement in the brochure then we would be misleading our customers, resulting in potential legal action," he said.

Another lender, Bluestone Equity Release, was forced, after it was contacted by the Australian Consumers Association, to broaden the guarantee in its documentation to include borrowers who sold their home to move closer to family members.

THE REAL COST

There is no such thing as a free lunch, so although you do not have to make repayments until you permanently leave the home, if you borrow using this product your debt, at current interest rates, would double in less than 10 years.

Using a property valued at $500,000, the value of the home will rise over time, depending on the average growth rate of property prices.

Movements in interest rates will see equity in the family home dwindle over the 15-year loan term.

For example, if property prices grow only slowly each year (1.95 per cent), a $200,000 loan over the next 15 years would swell to $670,943. The value of the home would rise to only $669,727, leaving the estate with a negative $1216, or nothing under the negative equity agreement.

And that's assuming no interest rate rises.

Borrowers can do their own calculations on the ACA website at http://www.choice.com.au

Catherine Wolthuizen, the Australian Consumers Association's finance policy officer, says the inherent risk of a variable interest rate may financially cripple some people.

"The interest rate rise on a reverse mortgage would be substantial," she says. "If property prices decline as a result of the increase in the cost of finance, what equity remains may also fall in value.

"It doesn't mean they shouldn't take up the opportunity to live in their family home and derive an income from it, but it does mean they have to make hard decisions about the real and likely future value of their home and what they are going to be able to afford in the future."

HOW IT WORKS

As each reverse mortgage product has its own variations, it would be wise for homeowners to examine each type of loan before signing on the dotted line.

All bar one product only offer variable rates of interest about 0.5 per cent to 1 per cent above the variable standard rate, currently at 7.07 per cent.

Bluestone's fixed rate is higher than the variable rate loans and attracts break fees should you decide to pay out the loan.

Other charges such as application fees and ongoing monthly fees may also apply.

In many cases these can be added to the loan amount so there is no out-of-pocket expense, apart from valuation costs in some instances. (Don't expect the lender to accept the highest valuation as it is in their interest to keep the valuation low.)

It should also be noted that if the fees are rolled into the loan, they are also subject to compound interest, along with the loan amount.

Repayment need only be made when the borrower moves out of the home permanently, either to go into long-term care, or on death, though it is possible to make repayments over the life of the loan. The all-important title deed of the home stays with the borrower, as does any capital appreciation.

The amount a retiree can borrow depends on his or her age and varies from 11 per cent to 45 per cent of the property's value.

Existing debts generally also need to be cleared so the lender is the only one to have security over the property.

The terms and conditions of reverse mortgages may also specify that the home is insured and that the property is maintained so the standard doesn't deteriorate. Periodic valuations may also be required.

SHOW ME THE MONEY

Generally there are two ways home owners can withdraw the equity: as a lump sum or a regular payment that can be used as an income stream to supplement the pension.

If a lump sum is withdrawn, interest is charged on the whole amount. If regular payments are taken, interest applies only to the outstanding balance of the loan.

COTA National Seniors' David Deans says there is a growing acceptance of reverse mortgages. "People are battling for income in retirement; they can have a better quality of life in retirement and still leave the main part of their assets to their children," he says.

"We joke about the SKI principle [Spend the Kids' Inheritance], but what you are actually doing is spending some of it. It is giving you a better lifestyle, you stay in your home, and you finish up at the end with something for the kids."

A study by Sweeney Research commissioned by Australian Seniors Finance, which surveyed both parents and their children, found that the children are supportive of their parents' tapping into the equity of the family home.

One response was: "I keep telling Mum I would prefer her to enjoy the money. She has worked hard for it and deserves to be rewarded now."

Australian Seniors Finance's managing director, John Thomas, says the response since the company launched its reverse mortgage last October has been well ahead of expectation.

It has received more than 5000 phone inquiries and processed 80 loans, with another 100 in the pipeline.

"It's a much more economical way for the kids to let their parents draw down on the house, because they have to get the money from somewhere. It is pretty hard to get a personal loan when you are 70, so they have to go to their kids or apply for a credit card, which charges about 16 per cent interest."

LOST CHOICES

The family home holds hallowed status in Australia, and particularly in its tax laws. Not only can it be sold capital gains tax-free, but it is also not counted as an asset for pension purposes.

However, once the equity in it is released through a reverse mortgage, Centrelink takes an interest.

Under the social security assets test, the first $40,000 of an unspent reverse mortgage is an exempt asset for 90 days after receipt. If after 90 days the part or full pensioner does not spend the loan, the full amount is included as an asset.

Investing the money is no escape as income is assessed under the rules applying to all financial investments.

COTA's Deans says his group is lobbying the Government to address the issue of reverse mortgages and pensions. He says in many cases people structure their finances so they qualify for at least $1 of the pension, as this brings other valuable benefits such as concession cards.

Wolthuizen says people should also consider other long-term implications of these products. She says people may realise later in life that they needed the equity in their home to move into aged care.

"It is extremely important that consumers are aware that their home may not be a 'magic pudding' of value into which they can endlessly chew," she says.

REGULATION

Wolthuizen and other consumer groups are also concerned about the lack of regulation. While welcoming the establishment of SEQUAL, she says self-regulation is not good enough.

As with other areas of credit, she says, unscrupulous and unqualified operators may move into selling these products so long as they remain unregulated. How do you ensure they are reputable?

Responsibility for regulating the sale of reverse mortgages falls to the states, as brokers do, as they are a form of credit rather than an investment product.

"While the Uniform Consumer Credit Code covers some aspects of the provision of credit, it is silent on some of the issues specific to reverse mortgages," Wolthuizen says.

"Given the particular risks and vulnerabilities of these products and their market, these are not matters which can be left to the individual contractual arrangements agreed between borrower and lender. Appropriate consumer protections must be put in place now to protect Australian retirees' homes."

NOT THE FINAL CUT

Kevin Aslop has been cutting men's hair in the Melbourne suburb of Oakleigh since 1956, when his father gave him an apprenticeship in the shop he bought in 1946.

Turning 65 this year and with an 80-year-old house needing repairs, Aslop knew one thing: if he sold up and moved to a cheaper area he would lose his customers and would not be able to work part-time. Gone would be the regular income, and he would also lose the companionship of his customers, many of whom have had their hair cut by Aslop most of their lives.

"If I had sold and moved to a cheaper place, what would I do to amuse myself? I don't play golf or anything like that, and if I work a couple of days a week I also get an income," he says.

This left one problem. With no money in the bank, how was he going to pay for the urgent repairs to his house?

Aslop says when he broached the idea of a reverse mortgage with his three adult children, they simply said: "Go for it, Dad."

"I figured if I could get 20 years out of it and make it to 85, there would still be something left over for the kids," he says.

ROOM TO MOVE

The Pension Loans Scheme is available through Centrelink and the Department of Veterans' Affairs for those on part-pensions and self-funded retirees who own real estate. Under this scheme, the retiree receives an income up to the full pension, which includes the pharmaceutical allowance. The full fortnightly pension is $393 each for couples and $470.70 for singles.

The family home or investment property must be used as security, with the loan and interest recovered from the estate. The loan attracts an interest rate of 5.25 per cent and there are no ongoing fees.

If you want to set aside part of the value of the property in case you have to move into a retirement home in later life, you can nominate a guaranteed amount for that purpose.

For example, if the property is valued at $210,000 and you want to set aside $85,000 your eligibility for payments is based on $125,000, the value of the property less the guaranteed amount.

You can get this loan even if you do not qualify for the pension because either your income or assets (but not both) are too high.

Centrelink has a financial information service that provides free information (not just for Centrelink customers) to help make informed decisions about investment and financial issues.

It doesn't recommend particular investments so there's no sales pressure and information is always independent. People wanting to discuss the options can make an appointment to see an information service officer by calling 132 300.