Everyone should understand the implications of a home equity release loan. Photo / Thinkstock
Q: Our 77-year-old mother is investigating reverse mortgages and we would be interested in your views.
It seems they have reinvented themselves in the past few years and are more attractive for folk wishing to free up money. Her home is mortgage-free but she has little cash flow except NZ Super.
ASB is offering these loans and we have had an initial meeting with one of its advisers. We were told that he is not on commission, and that the onus to follow up is on us - he will not call back. The process if she decides to continue is rigorous, with three further meetings and a family meeting too, to ensure everyone fully understands the process.
An amount to borrow is agreed upon and interest is only calculated once that facility is drawn down. The interest rate is always floating and is between 1 and 2 per cent above the current home lending rate, so it is currently 7.25 per cent.
If the facility is $50,000 and she draws down $30,000, the compounding interest after 5 years is about $13,000 (so she would pay back $43,000). And after 10 years the interest is about $31,000 (so she would effectively pay back double the amount borrowed).
The bank makes its profit on the compounding interest, which of course is fairly high. The loan can be repaid at any time without penalty. However, upon her death if it hasn't been paid back the house has to be sold and it is then paid back in full. There is a lifetime occupancy guarantee and a no negative equity guarantee.
There is a facility to protect a percentage of the value of the house. In Mother's case her house is valued at $550,000 and so she would specify a 50 per cent limit.
Our feeling is that if there is no other way for her to free up some capital, and if the three of us believe that she should be able to use the capital within her home to do as she pleases (in this case install gas heating, do repairs and maintenance and replace threadbare carpet), then it is a good facility.
The things she would like to do to her house will enable her to stay in it for the next five years at least, and she is very happy in it. We are not at all bothered about inheriting a reduced amount - in fact will get much pleasure from seeing her enjoy her home and life while she can.
There is a set-up cost of approximately $2000 - house valuation and solicitor fees - which she pays for.
What do you feel these days about reverse mortgages?
A: I think they're worth considering.
A reverse mortgage, a.k.a. home equity release, enables a retired person with a mortgage-free house to borrow against the equity in their house.
Usually the borrower makes no repayments until the house is sold, which means the loan grows with compounding interest - and this can be a big worry.
Your example of a loan doubling in 10 years is realistic. After 20 years, it would more than quadruple, and after 30 years - if you borrow at 65 and live to 95 - the loan would be more than eight times what you borrowed. And that's at current interest rates. If rates rise, it will be worse.
Of course, the loan growth won't be nearly that fast if you borrow gradually, which is what I would recommend - just taking out what you need. But still, you'll end up repaying much more than you got out.
That's not a rip-off. It's simply because the lender has given you the use of the money over many years. It's just the same as credit card debt growing if there are no repayments.
Partly because the loans grow fast, ASB isn't exactly pushing its reverse mortgages, which it calls HomePlus loans. "If we identify alternative ways of raising cash, we will recommend that customers consider these alternatives first," says Shaun Drylie, ASB's general manager, product and strategy.
"ASB has developed a three-meeting process that borrowers must go through before we will make a recommendation on HomePlus loans," he says. "They must also seek independent legal advice. These steps ensure borrowers understand the mechanics of the product, particularly the extent to which their debt will increase over time."
Although a family meeting is not compulsory, ASB encourages borrowers to tell their family and advisers what they're doing. And I agree - as long as family members are reasonable. As you say, a reverse mortgage usually reduces a family's inheritance. So it's probably best that would-be heirs know what's going on. It's an interesting test, actually. If they don't support the elderly person making use of some of the equity in their home, do the heirs deserve an inheritance?
Another worry about reverse mortgages is that the loan could become bigger than the value of the house - as has happened in the past overseas.
But Drylie confirms your comments about ASB's guarantees. "HomePlus meets guidelines developed by the Office of Senior Citizens. It guarantees lifetime occupancy, and customers will never have to pay back more than the value of their property. A 90-day cooling off period also ensures borrowers who change their minds can repay their HomePlus loan," he says.
ASB also offers an "equity protect" option, which you refer to. This "allows borrowers to protect up to 50 per cent of the equity in their home, so that no matter how much they owe, they are guaranteed to retain this portion of the equity (based on net sale proceeds) at the end of the loan," says Drylie.
"It can help provide customers with peace of mind, particularly if they wish to leave money for their estate. While customers can elect the equity protect option at no cost, it does restrict the amount they can borrow."
He gives an example of a $300,000 property, on which a 65-year-old is eligible to borrow up to $45,000. If they chose "20 per cent equity protect" the maximum loan would drop to $36,000.
Many years later, let's say the loan has grown to $340,000, and the house sells for a disappointing $400,000. The homeowner gets the protected value - 20 per cent of $400,000, or $80,000. This means the bank gets only $320,000, and has to accept the $20,000 shortfall.
It's fairly unlikely that a house's value would grow by only 33 per cent over a long period. But who knows what the future holds?
So, are reverse mortgages a good idea? I like the way ASB is doing this, with the guarantees, equity protection and series of meetings.
The loans are not cheap, with the set-up costs and relatively high interest rates. But the process sounds quite labour-intensive, especially at first. And the bank would also need compensation for the risk it takes that the guarantees and equity protection will work against it.
Overall, I think taking out a reverse mortgage is better than struggling financially and then leaving a valuable house to your heirs. But it's really important that homeowners fully understand what they are signing up for.
Drylie says ASB's reverse mortgages are "best suited for customers aged 65 or over, who own their own residential property (not by way of trusts or companies)".
He adds that "staff do not receive incentives or commission for selling HomePlus", which is excellent. It's not a product that should be "sold".
I congratulate you for noting that the adviser you met is not on a commission. Everyone should always ask financial advisers how they are remunerated.
Fee check
Q: I am interested to find a site where I can judge my KiwiSaver provider against others, as I am not convinced I am receiving the best management of those funds. The management fee charged seems inappropriately excessive to my mind, considering the significant contribution I make yearly.
A: I'm glad you're zeroing in on fees. The most important thing, of course, is performance after fees. But as we have no way of knowing which funds will perform best in the future, it's wise to concentrate on which funds charge low fees.
Next year, there will be more comparable info about KiwiSaver fees. But in the meantime, you can do pretty well by using the KiwiSaver fee calculator on www.sorted.org.nz. There's also info on fees at www.canstar.co.nz/kiwisaver.
Early start on savings
Q: I have a 2-year-old son and I am saving $30 a week into a savings account for his university studies and a deposit for his first home.
I would like to invest in a share-based fund for him to maximise growth potential, as this money is likely to be invested for up to 20 years. One of the options is to open a KiwiSaver account and contribute to this so that he can withdraw the money for a first home deposit.
However, I am nervous that if I start a KiwiSaver fund the rules will change in the next 20 years and prevent him withdrawing the money for a house deposit.
What investment vehicle would you suggest for this scenario?
A: Not KiwiSaver.
In some ways your letter is similar to one two weeks ago. In my answer I pointed out that it's good to open a KiwiSaver account for a child, so he gets the $1000 kick-start while it's still there.
But beyond that, because under-18s get no tax credits, you might as well save for him elsewhere to maintain flexibility. Look into non-KiwiSaver funds run by KiwiSaver providers, which include share funds.
Where your letter differs is your concern about the possible removal of first home withdrawals. And this is relevant, because once your son gets to 18 - and the tax credits and compulsory employer contributions start - it will be good to move your savings to his KiwiSaver account.
At 18, KiwiSaver becomes a great place to save for a first home. Even if your son doesn't qualify for the $3000 to $5000 first home subsidy - perhaps because his income is too high - he will still get employer and government money that he wouldn't get outside KiwiSaver.
While he can't withdraw the government money for a first home, he can withdraw all member contributions including money from you, plus employer contributions and all returns earned in the account.
Might a future government take away that right?
There are no guarantees, but it would astound me. Too many voters would be very angry.
• Mary Holm is a freelance journalist, part-time university lecturer, member of the Financial Markets Authority board, director of the Banking Ombudsman Scheme, seminar presenter and bestselling author on personal finance. Her website is www.maryholm.com. Her opinions are personal, and do not reflect the position of any organisation in which she holds office. Mary's advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following it. Send questions to mary@maryholm.com or Money Column, Business Herald, PO Box 32, Auckland. Letters should not exceed 200 words. We won't publish your name. Please provide a (preferably daytime) phone number. Sorry, but Mary cannot answer all questions, correspond directly with readers, or give financial advice.
House prices will be 20% lower in real terms by the mid-2030s than in 2021.