Small loans can very quickly become large ones

Reverse equity mortgages are increasingly tempting to retired Aucklanders who have houses soaring in value, but little cash.

But they come with a warning — a small loan now could become a large one later. It works like this: the bank pays out a portion of the equity in a home and registers it as a loan against the property.

No repayments are made but interest is charged until the property is sold or the owner dies. Usually, people have to be 65 to qualify.

There are three providers in New Zealand: ASB, Heartland Bank and SBS. But it's a growing business — Heartland paid $87 million this year for Sentinel, New Zealand's largest reverse equity mortgage provider.


Retirement commissioner Diane Maxwell said the loans appealed to people who were asset-rich but cash-poor and needed a lump sum.

"But the key thing is disclosure. People need to really understand the decisions they're making and the implications of drawing on equity. The downside of reverse equity is that you're on the wrong end of compounding interest."

Compounding interest is what makes saving pay off. Interest payments add to your total, and the higher total attracts more interest the next year. Compound interest means savings can increase by much more than the amount put in the account.

But when you have a reverse mortgage the opposite is true. Loans can become big, quickly.

An online ASB table shows a $10,000 reverse loan turning into $45,000 after 15 years because of compound interest.

Heartland has an example where a $50,000 loan turns into $150,000 after 15 years.

It would then increase even more quickly: 8 per cent interest on $150,000 is $12,000, taking it to $162,000 the next year. Then 8 per cent interest on that is $12,960, taking it to $174,960 the year after.

That's okay if the house increases in value but could be a problem if property prices stagnate or drop.

SBS Auckland area manager Matthew Isbister said one in 10 of his bank's customers were in the market for a reverse mortgage in Auckland.

"We're seeing a lot more interest in the product than three years ago."

Isbister said many retired people needed to renovate but did not have the cash. And they did not want to downsize or move away from their networks. He said a tiered structure that meant younger people could borrow less was to stop interest costs getting out of control.

Heartland said it had about 4000 customers. A spokeswoman said most customers did not have a loan for a long time. "Most people tend to repay the loan rather than go for 20 years." That was often because they decided to downsize.

Sentinel chief executive Vaughan Underwood said he would not recommend the product to people with other assets. "The loans are reasonably small so compounding interest takes a while before it reaches significant numbers but it still does reduce your options. We encourage independent financial advice and strongly encourage them to talk to their family."

He said a quarter of borrowers used the money for travel, often to see grandchildren in other countries.

None of the providers claw back more than the home is worth when the loan is repaid. There are options to ringfence portions of equity to ensure something is left to pass on to family members, but that reduces the amount that can be borrowed.

ASB's general manager of retail products and strategy, Shaun Drylie, said the bank had a three-meeting process to ensure the loans were the right option for borrowers.

"Through the process we ensure the customer understands the extent to which their debt will increase over time and that they must seek independent legal advice. We also strongly recommend that family and other advisers are fully informed."