Question About Reverse Mortgages

Question

I would very much appreciate your opinion on Reverse Mortgages. We are Superannuitants aged 76 and 78 with no other income aside from my part time job which brings in about another $7,000 a year. We have a mortgage free home valued at around $400,000 or possibly a little more. Due to my husband’s health problems and the fact that I come from a notoriously long-lived family, I am the more likely to be the last, of the two of us, to pop my clogs. Thus, I am a little wary of the whole idea as I see a high interest rate (9.5% or more?) eating away at the equity of our home until there is nothing left even for me, if I should follow the trend of my father’s family who mostly lived to around 99 to 103!

We have two children but they are happily both well off and not looking for money to be passed on to them. In fact they are keen for us to spend anything we have upon ourselves.

I would value your comments on this subject. My husband is very keen on the idea but then I think he, perhaps, has everything to gain and I may have everything to lose! I find your column very interesting and sound sense.

Answer

You are a hardy toiler, still working at 76 - amazing. Pity a good percentage of the population don’t take your lead and accept that there is a lot folk can offer, to not only their own wellbeing, but to the wider economy as a whole by not just giving up work at 60 or 65. Sure, some are not physically able, and that is fine, but many are.  The knowledge held and ongoing contribution by this widely undervalued resource is a sad loss to us all.

Now that’s said and off my chest - onto the real question: Reverse annuity mortgages or equity release schemes or life time loans as they are variously known.

We have not yet seen these schemes gain the traction that they enjoy in some overseas countries. Possibly due to the fact the first of these was rather fee heavy and not very widely known. They are very popular in the UK and a growing model in the USA for example.

How do they work? We’ll look at an option or two but before that let’s look at strategy. The main decision to consider is; do you wish to have access to a lump sum to replace a large asset, a new car or new carpet or general refurbishment maintenance or are you looking to supplement your New Zealand Government Superannuation from an income top-up perspective.

From your question I suspect you wish to top-up the Superannuation to replace your part-time work income when you eventually ‘retire’.

The setup or documentation is now somewhat more straightforward than previously and the legal folk are now becoming more aware of the product thanks largely to the efforts of one provider company, Sentinel. Still, there are a bunch of fees involved, product based, valuation and legal, and these need to be a well understood consideration before leaping in.

The normal impediment to making these plans a reality has not been so much the structure of the product or the fees and we do have a small number of folk that are very happy to be seeing a regular top-up of their cashflow from the annuity structure or the lumpsum come to hand. More, the problem we have seen, in number of instances, is where the wider family members or final beneficiaries of a future estate have intervened to stop the possible erosion of their potential inheritance – so much for family love!

The success or failure of these products from the property owner’s point of view is not the future performance of the real estate market or the amount of drawn down annuity or lump sum(s) taken. The success is in the reinsurance plan or repayment guarantee that supports you either living beyond the normal life expectations or the property market really taking a deep decline in valuation hence the pricing structure of the schemes.

For those folk over 60, that reach a point whereby the only option to enhance their cashflow and retain the current property is to liberate some of its capital value, before resorting to selling, they are a viable alternative in my view.

We have looked at various scenarios over time and our financial modelling appears to suggest that on current inflation and interest rates charged, with a modest annuity or reoccurring lump sum of around 3.00% of capital value per annum, the total equity in most properties, will be under threat at about year eighteen, should the product chosen allow these parameters.

In this instance a further option exists that could be considered, in my view, before going beyond the family. You make the comment that your children are relatively well off. If that is so, maybe you should discuss with them the option of raising a conventional flexible residential mortgage on your property that is serviced by them until such time as you are not in need of the asset.

This way you get access to a regular top-up as required. They only service the debt as you draw it down and the fees are minimal. This route will need a little bit of legal work to get ownership right and the mortgage documentation in the correct structure but certainly an alternative. Your children just take an ownership interest in the estate asset earlier than planned and also only cover the interest on your extra living expenses not the full capital cost.

This option does take a little bit of family cooperation but is very worthy of exploration.

Original Article published June 2006