Reverse mortgages

When people hit 65 they can still have 25 or 30 years of living to fund, thanks to increased life expectancies. A high proportion (60%) of those aged 65 and over depend entirely or largely on NZ Superannuation for their income. As a result, money can be tight, especially when unexpected expenses come up.

Enter reverse mortgages

A reverse mortgage or “home equity release” lets you borrow funds using your home as security. This means you can free up part of the value of your house without having to sell it. The lender gets its money back (plus interest) when your house is sold – which is usually when you go into full-time care or you die, or the last person named on the reverse mortgage document permanently leaves the property.

1. You must be at least 60 before you can apply for a reverse mortgage.

2. You can only borrow a percentage of your home’s value.

3. Your home needs to be mortgage-free, although you may be able to borrow if you have a small mortgage left and use the loan to pay it off.

Reverse mortgages generally come with a lifetime occupancy guarantee, which gives borrowers the right to live in their home for as long as they choose. They also usually offer a “no negative equity” guarantee that ensures that you –or your estate – won’t have to repay more than what your house sells for. You won’t be leaving your children with a debt if the house sells for less than the amount of the outstanding loan.

What if you want to leave something to your family, or keep something to pay for future care? The lender may offer equity protection, which guarantees a pre-set percentage of your equity is “protected” when it’s time to pay back the loan – no matter how much you owe. The drawback is that the amount you can borrow is reduced as a result of taking this option.

You can take the money as a lump sum, draw on it as needed, or receive regular payments. The last 2 options can help keep the interest down if you don't need the whole amount right away. But make sure the “regular payments” option won’t affect any income you’re getting from the government (this shouldn’t be a problem if all you get is NZ Super; if you get other assistance ask Work and Income about how it might affect you).

You can use the money for anything you want: holidays, cars, property maintenance, health care or just as an income top-up. Some people borrow because they want to stay in their existing home, with family and friends nearby. But they need a little more money to make life comfortable.

A report on the New Zealand reverse mortgage market by Deloitte Australia found that debt repayment was the most common use for the money, up from 14% in 2012 to 22% in 2013. This may indicate that the borrowers are going into retirement with their mortgage still not completely paid off. Home improvement was the next most common use with 18% using their loan for this in 2013.

The lenders

Heartland Bank offers reverse mortgages under its own name. SBS Bank continues to offer its Advance Loan. There may be other lenders – this report focuses on the banks only.

According to the Deloitte Australia report, the total value of the New Zealand reverse mortgage market is similar to the pre-global financial crisis period. But the number of mortgages has been decreasing while the average loan size has increased. In December 2008 there were 6878 reverse mortgages and the average loan size was $62,516. As at December 2013 there were 5338 with an average loan size of $83,229.

Protections

In 2008 the Ministry of Social Development developed a code of standards for reverse mortgages. The code is voluntary and not legally binding. Its standards include:

• lifetime occupancy
• “no negative equity”
• clear explanations of the conditions, charges, costs and responsibilities
• independent legal advice before you sign up
• access to an independent complaints process.

Getting independent legal advice before your loan is finalised is essential to make sure you fully understand how the reverse mortgage works.

Heartland Bank has a cooling-off period of 30 days and SBS Bank 5 days. Check the contract – you may get the application fee refunded if you change your mind and pay back the loan but, at their discretion, both banks are able to charge for reasonable expenses on cancellation, as well as any interest owing.

Both lenders are members of the Banking Ombudsman Scheme. So if you have a dispute about a reverse mortgage, you can make a complaint to the scheme.

Upsides

• Your loan might be portable – for example, if you decide to move to a new home or a retirement village.
• The lenders don’t ask you to make repayments during the life of the loan. Instead, the loan is paid off when the house is sold.
• If property prices increase this can help offset the interest costs.
• You don’t have to leave your home until you’re ready.

Downsides

• All loans require you to occupy the home. The lifetime occupancy guarantee only applies to those named on the loan agreement. If you have a partner whose name is not on the loan, they wouldn’t be able to stay if you died or moved into care.
• Interest rates are relatively high on these types of loans – up to 2% above regular home-loan floating rates. What’s more, the interest compounds and so can eat into your remaining equity. This can limit your options later.
• There are ongoing expenses that must be met to avoid being in default. For instance, the home must be fully insured, you must pay your rates on time, and you must maintain your property adequately.
• The provider may not lend on some types of property – for example, farms; lifestyle blocks; holiday homes; property held in trusts; retirement villages; or property owned by tenants-in-common.
• Upfront costs include having to pay legal fees and valuation fees. You could also have to pay for further valuations during the period of your loan.
• Other costs may include fees for top-ups, loan variations, equity protection, annual inspections, and loan discharges.

A calculated risk

Reverse mortgages benefit you when property prices are rising and interest rates are relatively low. When the reverse happens, the value of your equity can be rapidly reduced.

With help from the Commission for Financial Capability, we’ve come up with 2 hypothetical examples that show how equity can be affected by interest rates and house-price inflation (the houses in these examples do not fall into negative equity at the end of the loans).

Example 1

Harry and Margaret are both 70. They live in Mt Maunganui. They want to get a newer car, attend their granddaughter’s wedding in the UK, and have a bit more to live on each week. They decide to borrow a lump sum of 18% ($100,000) of their house’s current value of $546,000 (the REINZ national median house price for March 2017).

We’ve assumed that, over the term of the loan, interest rates remain at 7% (the average of the interest rates of our 2 providers) and house-price inflation is stable at 5% a year (this is the average of the annual percentage change in the March quarter house price index over the past 5 years).

Here’s what happens to Harry and Margaret’s debt and equity:

Example 2

Geoff and Liz are also both 70. They live in a small town. Liz needs a knee replacement and the roof needs replacing. They decide to borrow a lump sum of 20% ($63,300) of their house’s current value of $316,500.

This time we’ve assumed that interest rates rise to 9% and that house-price inflation is 2% a year (lower than it’s been over the past 5 years).

Here’s what happens to Geoff and Liz’s debt and equity:

Interest rates

Lenders charge a higher interest rate for their reverse-mortgage loans because they wait a long and uncertain period for repayment (repayments are typically paid at the end of the loan). The higher rate is the “premium” for having uncertainty about when the loan will be repaid.

We say

• Reverse mortgages are not ideal for everyone or every situation. Carefully consider what you need the money for – and how long you intend to stay in that particular house. You could be better off looking at other options.
• If you have a family, discuss the idea with them before you make a decision. Again, there may be other options.
• Get independent legal advice.
• Make sure the reverse mortgage offers lifetime occupancy, “no negative equity” and loan repayment guarantees.
• If you’re part of a couple, make sure both your names are on the loan document.