A recent phenomena in the finance industry has been the increased marketing and availability of "reverse mortgage" products for retirees to access the equity tied up in their family home, without having to sell their home. However, such loans are poorly understood by many retirees. A recent ASIC survey found that almost half of those with a reverse mortgage product did not know how much the loan would eventually cost. As there are around 31,500 such loans at present in Australia, worth around $1.8 billion, this could become a big issue. Retirees often have never had access to such a large lump sum of cash before, and can be in danger of spending it all and then having to radically cut their expenses when the money runs out. The loans are not particularly cheap (around 1% more than the standard variable home loan rate) and because the lender is taking on the longevity risk (Reverse mortgages are a form of equity release that allow retirees who own their own home to borrow against the property but defer all repayments until they die or the home is sold) the loan is often fairly small compared to the value of the property. If the lump sum is poorly invested or rapidly spent then the wealth tied up in the family home can easily be consumed by accumulating loan interest long after the initial loan has been spent.
For example, one retired man in his 70s spent more than $135,000 he obtained through a reverse mortgage in only two and a half years."I've been in business all my life and never had to budget. I might have to budget now.", Another woman borrowed $50,000 "in anticipation of needing it over the next three to five years", but then invested the money in a term deposit at a lower interest rate than the loan was charged. Other retirees were recently encouraged by financial planners (who were getting commissions of up to 10%) to take out home equity loans and invest the proceeds in mezzanine financing products that offered double-digit returns. The recent collapses of Westpoint property group, Fincorp and Australian Capital Reserve left such investors with nothing. While a reverse mortgage can be a good way to provide retirees with some extra income without having to sell their only significant asset (their house), it can be dangerous given the relatively poor financial literacy of the retirees being sold these products.
Copyright Enough Wealth 2007