Reverse mortgages can bedazzle the unwary
AN EXTENSIVE review by ASIC into the reverse mortgage sector has produced some surprising results.
While the regulator supports these often controversial mortgages as a product to help people enjoy a better retirement, it highlighted a key risk area that consumers need to watch carefully.
The statistics are clear; we are an ageing nation. The government predicts the number of retirees will balloon over the next 40 years. They expect that the number of people aged between 65 to 84 will increase from 3.1 million to seven million by 2054.
So where does that leave people's finances in retirement? In many cases … short, especially as they reach their 70s and 80s and find that they are outliving their retirement nest eggs. Perhaps a reverse mortgage is the answer.
Paul Dwyer, a reverse mortgage finance specialist, says, "a reverse mortgage allows people to borrow against the equity in their home through a loan arrangement. Interest is added to the loan balance and both the principal and accumulated interest is repaid typically when the borrower either moves into aged care or passes away".
In Australia, the market is concentrated with Commonwealth Bank and subsidiary Bankwest issuing 68 per cent of new reverse mortgages and Heartland Seniors Finance issuing 12 per cent. ASIC identified the problem for new lenders being high capital adequacy requirements, high wholesale funding costs and challenges to make a profit with interest rates at record lows.
However, ASIC deputy chairman Peter Kell supports reverse mortgages, saying "reverse mortgage products can help many Australians achieve a better quality of life in retirement".
ASIC reviewed data from 17,000 reverse mortgages, 111 consumer loan files, lender policies, procedures and complaints.
ASIC staff also interviewed 30 borrowers and 30 industry and consumer stakeholders. The corporate regulator found borrowers had a poor understanding of the risks and future costs of their loan, and generally failed to consider how their loan could affect their ability to afford future needs, such as aged-care fees.
In terms of what the reverse mortgage set out to do, which was mainly to provide a lump-sum cash injection, 100 per cent of borrowers ASIC interviewed said the reverse mortgage enabled them to achieve their original objectives for the loan.
ASIC's main criticism of reverse mortgages was that lenders and brokers tended to focus on the borrower's short-term objectives, while there was little or no attention paid to their future needs. There is a sting in the tail … reverse mortgages can solve a short-term problem - a lack of cash - at the expense of a longer term objective, such as getting the full value from owning a family home.
In fact, 92 per cent of loan files reviewed did not record anything to do with the possible future needs of the borrower.
Sydney financial planner Peter Lambert says, "reverse mortgages aren't always bad news and should be considered as one of the financial options people have in retirement. Based on the average reverse mortgage balance of $118,627 against an average home value of $632,598, based on 3 per cent property growth per year, over a 20-year period people should actually see an increase in their home equity, net of the accumulated interest cost by over $200,000".
The key to taking out a reverse mortgage is to make sure you are not bedazzled by the large amounts of potential money being dangled in front of you and to consider the long-term impacts of compounding interest on the loan balance.
Talking to a broker or financial adviser who provides holistic advice is a good first step.
James Gerrard is the principal and director of financial planning firm FinancialAdvisor.com.au
This story first appeared in The Australian.