I often hear the story where people have built and renovated their home over the years to exactly how they want it, love the area they live in, and see their retirement future there. No downsizing or seachange here, as there are plenty who want to stay exactly where their friends are.
Makes sense – the problem is that for some, they have put all their extra potential retirement savings into the house ‘Asset Rich but Cash Poor’ as they say. Now retirement day approaches and their super balance and savings is not where they need it to be for the lifestyle they want.
While we can always look at that super balance and get the funds working harder for them in this next stage of life, it does make it harder if you have stopped work and no more contributions to add.
There are only three options we see in this scenario to get the extra funds needed:
- They have to move and downsize – which they clearly don’t want to do as have their perfect house
- They have to continue to work – which they don’t want to as they want to start enjoying this new phase of their life
- Use the equity in their home – they can then stay in their home, and not have to work
So let’s talk about how you can use the equity in your Home:
The main way to do this is to use a Reverse Mortgage and there are a few variations on this nowadays. Now these types of products had a bad name for a while as for some rare cases, when the couple passed away, they had used up all the equity in the home and more, and then owed money on their passing which the estate or beneficiaries would have to pay.
They have definitely improved since then which I will explain but also need to emphasise, as such a major financial move, please get financial advice if considering this.
So what is a reverse mortgage? It’s a mortgage which allows you to borrow money using the equity (value of your home minus any debt) in your home as security. You can still live in your home but you now have access to funds for extra income, renovations and similar.
If you’re age 60 for example, the most you can borrow is likely to be up to 20% of the value of your home. As a guide, add 1% for each year over 60. So, at 65, the most you can borrow will be about 25%. The minimum you can borrow varies, but is typically about $10,000.
The Government has also become involved (with the negative press in the past) and so depending on your circumstances, you have a few choices in this market now (most with protection) and so will go through what they are here:
Ways to access equity in your home include:
- reverse mortgage
- home sale proceeds sharing (home reversion)
- equity release agreement
- the Government’s Pension Loans Scheme
MoneySmart, the Government financial website has a lot more information on this and also a great calculator here to help – reverse-mortgage-calculator
1.Reverse Mortgage – how it works
Your home provides the security for the loan, and you are allowed to live there and not have to make repayments while there. Interest charged on the loan compounds over time, so it gets bigger and adds to the amount you borrow. The interest rate is likely to be higher than on a standard home loan. Check the rates as traditionally they were around 6% pa but now with competition have seen them drop to around 4% pa.
Importantly you repay the loan in full, including interest and fees, when you or your estate sell your home after you pass away.
Important – Negative equity protection
Reverse mortgages taken out from 18 September 2012 have negative equity protection. This means you can’t end up owing the lender more than your home is worth (market value or equity). Before this date the loan would keep growing and could exceed value of home depending on life span.
2. Home sale proceeds sharing
This is new and I have had no experience with these so providing information from MoneySmart website and so please research these carefully and get advice.
‘Home sale proceeds sharing’ (or home reversion) allows you to sell a proportion (a ‘share’ or ‘transfer’) of the future value of your home while you live there. You get a lump sum and keep the remaining proportion of your home equity.
The provider pays you a reduced (‘discounted’) amount for the share you sell. How much you get for the share depends on your age. The amount you get back depends on when you sell your home and how much you got for your sold share. You may also have the option to buy back the sold share later, if you wish.
For example, suppose your home is currently worth $500,000 and you sell a 20% share of the future value. Depending on your age, the provider may offer you $37,000 to $78,000 to buy that share today. When you sell your home, the provider receives their share of the proceeds. Say in 20 years time you sell your home for $800,000. The provider gets 20% of the sale price ($160,000), minus any rebate (if applicable).
Also important is it’s not a loan, so you don’t pay interest. You pay a fee for the transaction and to get your home valued (as a guide, around $2,000). You may also have to pay other property transaction costs.
3. Equity release agreement
An equity release agreement allows you to sell a portion of the value of your home. You get a lump sum or instalment payments in return. You live in your home and pay fees for the portion you’ve sold. A bit like paying rent on it. Your proportion of equity reduces over time, to cover the fees you pay.
For example, suppose your home is currently worth $500,000. You sell 20% of your home’s equity in return for a lump sum of $100,000. The fee charged by the fund may vary, depending on your circumstances and the agreement. If the fund charges an initial fee of $30,000, it may take $130,000 of your equity to cover both the lump sum and periodic fee.
Additional amounts of equity are deducted each time the periodic fee falls due (such as every 5 years). The fee is a set percentage of the fund’s equity in your home. So, as the fund’s share of equity increases, the fee goes up. The proportion of home equity you keep will reduce over time, and could even go down to zero.
Check your agreement to see what happens if your equity goes down to zero. Make sure you can continue living in your home, until sold by you or your deceased estate.
4. Pension Loans Scheme
The Pension Loans Scheme is provided by Services Australia and the Department of Veterans’ Affairs. It lets eligible older Australians get a voluntary non-taxable fortnightly loan from the Government. You and your partner may use this to supplement your retirement income.
You can choose the amount of loan you get paid fortnightly. Your combined pension and loan payments cannot exceed 1.5 times the maximum fortnightly pension rate.
The loan is secured against real estate you, or your partner, own in Australia. You can choose how much you offer as security.
There is a maximum amount of loan you can borrow over time. This is based on your (or your partner’s) age and how much you offer as security for the loan. The Pension Loans Scheme is not paid as a lump sum.
You must repay the loan and all costs and accrued interest to the Government. You can make repayments or stop your loan payments at any time.
Lorenzo and Sophia consider getting a reverse mortgage (example from MoneySmart Website)
Lorenzo is 70, Sophia is 65 and their home is worth $500,000. They want to renovate, but don’t have enough savings.
They use the reverse mortgage calculator to explore what a loan might cost. Based on Sophia’s age, the most they can borrow is 25% of the value of their home: $125,000. They want a lump sum to pay for the renovations.
They allow $1,000 for loan set-up fees and use the default interest rate of 7%.
In 15 years, if their property goes up in value 3% each year, it will be worth $779,984. They will own 54% of their home ($420,016), and owe the lender 46% ($358,967).
They decide to get financial advice and consider borrowing a smaller amount.
I hope this helps provide a bit more information on a little-known subject. Our aim is for everyone to reach financial freedom and that means having enough saved to fund the retirement they want, including owning their own home. It is important to know there are other options and if appropriate can work for you, as once you reach this next stage of life, you want to be able to enjoy it, as you have worked hard and deserve it!
Article by Marc Bineham – Money coach, speaker and award-winning author of The Money Sandwich