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.
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“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.