Pathway opened to accessing home equity
A longstanding and largely unpopular government loan scheme has received a much-needed boost in last week's budget.
Now revamped, it should be given a second look from retirees who may have previously dismissed it, or indeed may have been completely unaware of its existence.
For the past 30 years, the Pension Loans Scheme (PLS) has been available to those on a part age pension. It provides a loan paid on a fortnightly basis to top up a part age pension to a full age pension.
This loan, commonly known as a reverse mortgage, is secured against property with interest compounding at 5.25 per cent, payable along with the amount borrowed upon the ultimate sale of the property.
Until this year the PLS was virtually dormant because it was so restrictive, but in the budget the government dropped most of the restrictions and it will now be open to everyone of pension age. But, there is one effective restriction left on the PLS which is a limit on the income that may be drawn from it per annum - $11,799 for singles or $17,787 for couples, and that level is too low for many.
Jim Ellis, personal mortgage adviser with Smartline, says: "I just completed a reverse mortgage for $2.2 million and the average reverse mortgage application would be between $200,000 and $300,000. The Pension Loans Scheme has been useful to top up fortnightly income in the range of a few hundred dollars, but for many this has not been enough to make a meaningful difference in achieving the things they wish to do in retirement".
Another issue has been the timing of the payment from the scheme. Ellis says: "although normal reverse mortgages offer the option to receive a regular income stream, most people opt for a lump-sum cash payment and use the money straight away for things like renovations and holidays rather than be drip fed to them over time, like the Pension Loans Scheme (does)".
Nonetheless, financial planner Peter Lambert thinks the scheme will now be more widely taken up by the 2.5 million retirees who receive the age pension. He says: "people who receive a full age pension have previously been excluded from the Pension Loans Scheme but can now supercharge their fortnightly payments with up to an extra $454 for singles and $704 for couples from the PLS".
The other group of people that may benefit from the change are part pensioners who have not been persuaded in the past to apply for the PLS as it wasn't worth the hassle. But now the proposition is more appealing.
For a couple on a combined age part pension of $500 per fortnight, prior to the federal budget the maximum top up from the PLS would have been $908 per fortnight. However, from July 1 next year they will be able to top up by $1612 per fortnight under the boosted rules.
For those on a part pension, the overall level of household income has generally been falling over the past 10 years and an injection from the PLS may just be the right shot in the arm.
Lambert says: "We have to remember that interest rates are at historic lows, which is impacting people's overall retirement income. Ten years ago, term deposit rates were eight per cent whereas now we are lucky to get three per cent".
Another benefit of the PLS is the lower than market interest rate. Ellis says: "interest rates on reverse mortgages are currently between 6.15 per cent and 6.45 per cent whereas the Pension Loans Scheme interest rate is 5.25 per cent".
But anyone examining a reverse mortgage of any type should not forget the major drawback of reverse mortgages - although they are an avenue to unlock equity in a property, the interest on the loan compounds, leading to exponential growth of the loan balance over time as interest is charged on interest.
Paul Versteege, policy co-ordinator at the Combined Pensioners & Superannuants Association, says reverse mortgages, including the government's scheme, are really a "last resort" for older people to raise money. "Over time, the interest mounts up and eats away into the home owners' remaining equity and limits the ability to downsize or move," he said.
Traditionally, the main alternative to reverse mortgages has been to sell the family home and downsize to a smaller property. However, transaction costs need to be considered.
For someone who sells a $1m house and downsizes to a $800,000 property, the amount left over is not $200,000 in cash. Selling incurs legal fees and real estate agent costs of up to $25,000 and when purchasing there is stamp duty of $40,768 in NSW or an eye-watering $57,550 in Victoria. So the $200,000 difference reduces to as little as $117,450 in cash after transaction costs, making the exercise hardly worth it for many.
What could work very well is if the Federal Government sought to cover at least part of the state-based stamp duty cost for people who wish to downsize the family home. It would allow a more fluid transition into smaller housing for retirees, boosting the supply of family homes for the younger generation to purchase and also provides a bigger cash residual for retirees post-downsize.
James Gerrard is the principal and director of Sydney financial planning firm FinancialAdvisor.com.au
This story was first published in The Australian.