The Smooth Retirement team picked up on an article in The Age last month which cautioned retirees on the potential risks of using home equity, highlighting two examples where reverse mortgages had left borrowers with prohibitive break costs and a growing debt at fixed interest rates – a situation they felt they were unable to get out of.
The two case studies focused on loans provided by the Bluestone Group, which specialises in low-doc mortgage loans but has since stopped offering its fixed rate reverse mortgage product.
Unlike other current reverse mortgages, Bluestone borrowers could not voluntarily make payments or pay out the loan early without incurring a significant ‘break fee’.
In both reported cases, the break fees were staggeringly high, calculated at more than $100,000 which in the example of the borrower named Pam, was almost as much as her total loan + interest balance of $110,700.
There is a legacy of borrowers like these who took out these loans some 13 or more years ago and are stuck with higher fixed interest rates and break fees.
What Smooth Retirement wanted to understand was what these cases would look like if applied to today’s style of reverse mortgages which have lower, variable interest rates and no break costs.
Today’s reverse mortgages allow borrowers to sell their homes at any time and/or pay out or refinance the loan as well as make regular or ad hoc repayments including paying interest – all without any penalties.
We used our equity release planning software to model both cases, applying one of Australia’s leading reverse mortgages.
Let’s start with Shirley, who took a loan of $100,000 at 8.59% on her home in 2006 and now has a total loan of $242,000 with a break cost of $126,500 ($368,500 in total).
If Shirley was to take out a reverse mortgage for $100,000 today at a variable rate of 6.20% (calculated daily and debited to the loan account monthly), then after 13 years, the total balance would be just over $220K. Shirley could choose to make payments to the loan or sell her house at any time throughout the loan period with no penalties or break costs.
Now let’s look at Pam, who took out a loan for $37,500 at a fixed rate of 8.39% some 13 years ago and now has a total loan balance of $110,700 with break costs of more than $110,000.
In the case of Pam, if she took a reverse mortgage today for $37,500 with the same features as Shirley’s loan above (variable rate of 6.20% calculated daily and debited to the loan account monthly) then in 13 years’ time, the loan balance would be just less than $84K. Again, there would be no break costs and Pam could choose to sell the home or pay out or refinance the loan at any time.
The value and location of Shirley and Pam’s houses were not reported in the article, but let’s say they were located in Sydney, with a conservative value in 2006 of $650,000 and were to have grown at an annual rate of 2% then today they would be worth around $840,000.
Based on the calculations above, and if the features of today’s style of loan were to be applied with variable rates and more importantly no break costs, this would give Shirley a net statement of position (assets minus liabilities) of about $620,000 and Pam of $756,000.
Even with their Bluestone fixed rate loans and high break costs, it is likely that Shirley and Pam would have benefited from capital growth over the last 13 years which should be taken into account when considering their overall statement of position. If they’d sold their homes 13 years ago to free up the cash that they required (Shirley $100K and Pam $37.5K), paid transaction costs (real estate agent fees and stamp duty on the purchase being the bigger ticket items)and then bought again into the market, the amount of value that they would have had exposed to real estate, would have been less. In Sydney during the last 13 years, property prices have roughly doubled. So, depending on the value of their homes 13 years ago, Shirley and Pam’s net worth is likely to be similar today than it would have been, even taking into account high fixed rates and break costs.
If you’re considering using some of your home value to fund your retirement, the right planning is all important, and needs to consider all your sources of income (account-based pension, Age Pension and other income) along with any of your savings and the reduction in home equity over time, estimated capital growth and future needs such as aged care and inheritance options.
What Smooth Retirement has learnt is that many Australians will need to use some of the value in their home to fund part of their retirement. And for most Aussie retirees, their home is their most valuable asset. It makes sense therefore to explore all your options so you can determine the best strategy that will allow you to make the most of all your assets, including your home.
If you’re considering using some of your home equity to fund your retirement, then get in touch with our team today on 1300 510 015. Our consultation service is free.
Smooth Retirement Pty Ltd is an independent service providing expert guidance in equity release and retirement income planning Australia-wide. ABN: 46 619 010 445; AFSL 510015; Australian Credit Licence: 510015; smoothretirement.com.au; firstname.lastname@example.org; 1300 510 015. Terms, conditions, fees and charges apply.