KEY POINTS:
The equity that reverse mortgage holders have tied up in their homes is being squeezed sharply at present between falling house prices and interest rate hikes resulting from credit market turmoil.
Leader in the reverse mortgage or "home equity release" market Sentinel recently increased its variable interest rate
to 11.95 per cent.
Sentinel says it aims to maintain its variable rate, favoured by the vast majority of clients, at approximately 1.5 percentage points above the major banks' variable mortgage rates.
The major banks have increased these rates in recent months along with those for fixed mortgages, citing the increased cost of wholesale funding due to credit market conditions.
Sentinel chief executive Vaughan Underwood, who is also chairman of industry group the Safe Home Equity Release Plans Association, said Sentinel had absorbed previous increases but had now been forced to pass them on to clients.
"We are exposed to what's happening internationally as 90 per cent of our funding is sought offshore, and we just have to ride that out."
Underwood said a 50 basis point increase meant an extra $200 on the typical client's loan for the year.
"In the scheme of things that's not a reason to be too panicked."
Nevertheless the increase, particularly if it is sustained, will inevitably accelerate the rate at which compounding interest sees clients' loans grow at the expense of the equity they hold in their home.
The increase comes hard on the heels of data showing house prices are beginning to fall, with further declines seen as almost inevitable as the housing boom unwinds. Underwood said interest rates were "quite a small part of the equation" for people taking a home equity release loan.
"Property value appreciation and how long they stay in their home make a huge difference on the remaining equity left for their heirs."
Sentinel allows for 4 per cent per annum appreciation in house value for actuarial calculations, and while Underwood acknowledged that a period of house price deflation was a possibility, it was likely to be short lived compared to the term of the typical loan. "This is not a business that's exposed to short-term property corrections."
Meanwhile, although Underwood acknowledged that reverse mortgages were a particularly secure form of lending, some margin had to be charged for the lack of cash flow over the generally long term of the loan, and companies had to manage the risk represented by the "no negative equity" guarantee Sentinel provides. Sentinel manages that risk through insurance.
HOW IT WORKS
* Interest rates for "reverse mortgages" or "home equity release loans", already higher than conventional mortgage rates, are also on the way up.
* Reverse mortgages enable a person over 60 to borrow against some of the equity in their home. The loan and its accumulated interest is repaid when the person dies or the home is otherwise sold.
* Recent rate hikes along with falling house prices mean the loan will grow to match the value of borrowers' homes much faster.
* Sentinel, which has as much as three-quarters of the $350 to $400 million market, has a "no negative equity" guarantee which means that if all the equity is used up the mortgage holder or their heirs will not be left with a debt.
