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Why we shouldn’t be afraid of reverse mortgages

Yes, we are right to be wary of financial products that take money out of a home, like reverse mortgages. But properly managed, they will be necessary to ensure that we are equipped to care for an ageing population.

The family home is sacrosanct, and when innovative housing finance schemes go wrong, they go horribly wrong. Think of the US sub-prime mortgages that triggered the global financial crisis — the dreaded “NINJA” loans (to borrowers with no income, no job or assets), and the toxic collateralised debt obligations that attempted to spread the resulting risk of default.

Australia was lucky to dodge the sub-prime meltdown — our flirtation with low-doc lending was relatively small, instances of loan application fraud by mortgage brokers were swept under the carpet — but we have had our policy failures, too, like the HomeFund fiasco of the early ’90s in NSW, when thousands of often elderly public housing tenants were encouraged to buy their homes with funds raised from bond markets. Interest rates in the high teens during the “recession we had to have” quickly put thousands of low-income borrowers into negative equity — when the value of the loan exceeds the value of the secured property.

Australians have remained wary of so-called “equity release” products like reverse mortgages that allow asset-rich but income-poor retirees to access the equity in their own homes.

Yet in the last few days both the Productivity Commission and the Grattan Institute have given currency to the idea that we will need to develop the market for equity release products if we are to bridge Australia’s enormous looming, structural gap in funding for retirement income and aged care.

Retirees tend not to use the wealth in their family home,” the PC wrote, suggesting a government equity-release scheme. ”Policy measures that overcome the barriers that individuals and households face in accessing the equity in the home may play a future role in freeing up resources for greater contributions to age-related expenses.” The PC estimated if the government could access half the increase in home values, age-care funding needs would fall 30%.

At the moment the family home is excluded from the asset test used to calculate eligibility for the aged pension, and the Grattan Institute recommended removing this exclusion. People who failed the asset test due to the value of their dwelling would be allowed to receive the aged pension, but they would accumulate a debt to the government, to be paid when the home was transferred or sold — in effect, the government would provide a no-interest reverse mortgage. Grattan reckoned this would save $7 billion a year.

There would be less need for such government equity-release schemes if there were a larger private market. Deloitte Actuaries & Consultants estimates the overall market for equity release products grew 7% to the end of 2012, with some 42,000 borrowers taking $3.5 billion in loans.

That is a minuscule fraction of the home lending market, and Deloitte partner James Hickey calls it an opportunity missed: “There is a clear potential for even greater growth in this market as the size of the senior Australian population is set to increase by more than 50% in the next decade.”

Hickey says the market was dominated by non-bank lenders like Bluestone and ABN-Amro, but these have fallen away in the wake of the GFC, to be only partially replaced by major lenders such as the Commonwealth Bank and St George, which both have reverse mortgages.

The annual Deloitte report was commissioned by the Senior Australians Equity Release Association (SEQUAL), which has wound down operations after new tighter regulatory controls were introduced under the Gillard government’s reforms to the Consumer Credit Code. Under the reforms, Australian providers of reverse mortgages must provide a “no negative equity” guarantee, which makes sure borrowers — who must be over 60 — cannot end up bequeathing a debt to their beneficiaries.

The risks with reverse mortgages are obvious: as Ross Greenwood pointed out on Sunday, compounding works triply against borrowers who are making no repayments, with interest racking up not just on the principal, but on the unpaid interest.

This risk is exacerbated because it is very difficult to offer fixed interest rates over an open-ended mortgage, so any movement in interest rates makes a huge difference.

ASIC provides calculators to help borrowers but, on back-of-the-envelope numbers, Hickey estimates a person who borrows $100,000 over 20 years at an interest rate of 6.5%, against a home worth $500,000, would see the loan balance grow to $350,000. If the interest rate rose to 10%, the loan balance would rise to $670,000. This would be enough to wipe out the equity in the home, although if the value of the property grew by 5% per annum it would reach $1,350,000 after 20 years.

An alternative product, a home reversion mortgage, offered by Homesafe Solutions, a joint venture of Bendigo and Adelaide Banks, avoids this problem. The home owner effectively sells a proportion of the home at a discount, and Homesafe keeps the upside in the value of its share in the property when it is ultimately sold. There is no accumulating interest bill, and home owners can be sure they can bequeath a fixed proportion of their home to their beneficiaries. Homesafe told ACA last week it had advanced some $300 million to 2500 borrowers under the scheme.

Michael Sheriss, a professor of actuarial studies at the University of New South Wales Australian School of Business, has written a recent paper on how Australia might develop the market for equity-release products. He believes there is definitely potential for the market to help bridge the funding gap. Perhaps it is with a government-insured product like the Home Equity Conversion Mortgage in the US, which is the safest and most popular program and accounts for 95% of the market there.

A government program already exists here, the Pension Loans Scheme through Centrelink, in which the house is used to borrow a top-up amount for your pension and is usually repaid from the estate after death.

Even more exotic products are offered by the likes of POPI Australia, which attempts to pay an income to the home owner in exchange for taking the upside in the value of the property, or DOMACON, which tries to match retirees looking to partially sell down their homes with self-managed super funds looking for exposure to residential property without being able to buy a whole home.

It would be foolhardy in the extreme to count future house price growth as money already in the bank. Renegade economist Steve Keen warns that Australia’s elite seems to see rising house prices as the panacea for every problem, when in fact they may cause many of our social and economic ills.

The growth of the equity release market would need to be tightly regulated — from Westpoint to MFS to Storm Financial, we have seen billions of dollars of damage to retirement savings already, without letting aggressive lenders and their agents get their clutches on often vulnerable people’s homes. Reliance on disclosure, where home owners are not financially literate, would not be enough.

But all financial risks can be managed.  We are going to have to get more mature about the risks  involved to access the huge amount of untapped wealth that is undoubtedly tied up in our homes.

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  • 1
    Gary Johnson
    Posted Wednesday, 27 November 2013 at 2:45 pm | Permalink

    It would be foolhardy in the extreme to count future house price growth as money already in the bank. Renegade economist Steve Keen warns that Australia’s elite seems to see rising house prices as the panacea for every problem, when in fact they may cause many of our social and economic ills.”

    Correct, it’s on everybodies lips again. The banks are leaning in mass with lowdoc loans ( 5% deposit and sometimes less )and excessive valuations all over again. Rising house prices are viewed by nearly all financial agencies as one size fits all.

    They can spin it all they like. They can invent new formulars and mathematical equations all they like, but placing the financial security of the frail and vunerable in the hands of financial institutions and Govt agencies in the form of Reverse Mortgages is an act of impure white-flag lunacy and desperation.

  • 2
    Matt Hardin
    Posted Wednesday, 27 November 2013 at 4:25 pm | Permalink

    Why not bring back death taxes and be done with it. Also why is no one talking about increasing income tax for the top earners?

  • 3
    The Pav
    Posted Wednesday, 27 November 2013 at 5:02 pm | Permalink

    I don’t believ that reverse mortgages are an appropriate product for the banks to offer, Many reasons but the product does have a limited space available to it but it should come from a single statutory lender

    Whilst the Gratton Institute’s suggestion that the family home be subject to CGT is reasonable it will fail as being politically untenable. Perhaps then there should be a threshold.Say $5M,that wouldn’t affect the average Joe Bloe but should be a nice little earner.

    I mean if you assume prices go up 10% then for a $500K house thats $50K tax free as against $500K for a $5M house, Takes away one leverage advantage for the rich while helping the average punter

  • 4
    AR
    Posted Wednesday, 27 November 2013 at 9:27 pm | Permalink

    Abolish negative gearing for investors for starters, then drop the First Home sellers subsidy, consider making owner/occupier interest semi tax deductible (it is fully deductible in UK) and ..errr introduce a steeply ascending graduated tax system.
    No chance of a Swiss 1/12 referendum here and it failed by 2/3 there but it’s a nice thought.
    Finally a Tobin tax on capital movements.

  • 5
    Dogs breakfast
    Posted Thursday, 28 November 2013 at 9:15 am | Permalink

    All good points here. Relying on growht in house prices is a sure way to hell. There is no question that we are currently on the upper limits of what people can pay as a % of their take home pay, and it is very hard to see that moving, and the kicker is that it even with interest rates at record lows.

    The situation now is such that even a reversion to historically normal interest rates will have a nasty effect through the whole economy.

    While taxing the home may have some benefits, it is politically untenable and not such a great deal. so muhc lower hanging fruit, the negative gearing of property top of the list.

    All countries will struggle with revenue until an international Tobin tax is instituted. There are huge benefits and huge revenues for governments in this.

  • 6
    JMNO
    Posted Thursday, 28 November 2013 at 9:35 am | Permalink

    Bear in mind that when people move in low-care aged accommodation they have to pay a bond, which varies in amount from provider to provider (I know of bonds from around $200,000 to over $500,000)and that many people sell the family home to pay this bond.

  • 7
    JMNO
    Posted Thursday, 28 November 2013 at 9:59 am | Permalink

    And the $200,000 was about 8 years ago so has probably gone up

  • 8
    Edward James
    Posted Thursday, 28 November 2013 at 11:51 am | Permalink

    Reverse mortgage another alternative for all those people who have run out of money. Are we following the lead of governments with the almost constant round robin of borrowings, which taxpayers pay? When I buy my next place it will something I can afford to buy for cash. Edward James

  • 9
    The Pav
    Posted Thursday, 28 November 2013 at 12:26 pm | Permalink

    JMNO

    A bond is fine and selling the house makes sense.

    If you move house you sell to pay for the new one.

    Moving from the house to a NH is really the same so selling the house imakes sense.

    The problem occurs when nthere is an illness separated couple or dependants in the house but these are not insurmountable and the bond should reflect this

  • 10
    Robert Maxwell
    Posted Friday, 29 November 2013 at 10:05 am | Permalink

    A distinction I would make about the family home is that it not all savings like some other investments There is a large part of asset price inflation involved.The family home is about security, a sense of place and legacy. In that very real sense it is a home not a house. My observation is that if we allow things to be financialised they join the hyper concentration of wealth that is destroying the consumer, middle class base whilst shifting the money to rent boys.

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