Proceed with caution with home equity borrowing
AUSTRALIA'S over-65s collectively have $500 billion in home equity, and for older workers heading into retirement, a reverse mortgage can seem an attractive way to pocket a bit of extra cash without having to sell the family home. But borrowing against what may your best asset is not a step to be taken lightly.
Unlike a traditional mortgage, no regular repayments are required on a reverse mortgage. The loan plus accumulated interest is paid off when the owner passes away or moves into a nursing home or aged-care.
The funds can be taken as a lump sum or regular payments, and you're free to spend the money as you choose. Several years ago, 'negative equity protection' became mandatory on all reverse mortgage products so borrowers can't end up owing more than their place is worth.
It all sounds very tempting. However, there are drawbacks, not the least of which is that only five brands have, until recently, controlled 99 per cent of the market. Today, there are only three major reverse mortgage providers - Bankwest, Commonwealth Bank, and Heartland Seniors Finance.
A lack of choice rarely works in consumers' favour, and one impact of this is that the rates on reverse mortgages are much higher than for regular home loans - 6.27 per cent in the case of Bankwest and 6.29 per cent with Heartland Seniors Finance.
The bigger drawback, according to a review by ASIC, is that home owners don't always grasp the long term risks - in particular the potential for mounting interest costs to eat away at home equity.
A 60-year old borrowing $118,000 (the average size of a reverse mortgage) today at 6.3 per cent could owe $392,000 by age 80. If rates rose by just 2 per cent, the debt could snowball to $550,000.
Using your equity this way will mean leaving a smaller estate. That shouldn't be an issue if you're faced with the choice of living a hand to mouth retirement or enjoying a decent lifestyle.
The real crunch can come if you need to fund expensive medical treatment or move into aged care later on.
That said, I am pro reverse mortgages providing only small amounts are drawn down - and you borrow only a low proportion of your home's value. Check the loan fees you're paying too. These can be just as damaging to your home equity over time as a high rate.
Always ask a trusted, independent party - preferably your solicitor, to check the loan contract. Never sign anything you don't understand. And speak with Centrelink to see if payments from a reverse mortgage could affect your age pension entitlements.
Paul Clitheroe is Chairman of InvestSMART, Chairman of the Australian Government Financial Literacy Board and chief commentator for Money Magazine.