Taking out a reverse mortgage when you're relatively young can result in a much bigger debt than if you wait until you're older. Photo / 123RF
COMMENT:
I'm approaching 50, and my wife and I are considering early retirement in the next few years.
Like many couples who were fortunate to get into the Auckland property market many years ago, a large proportion of our assets is tied up in our home, which we own mortgage-free. We have no children and do not plan to leave a financial legacy.
As such, I am considering a reverse mortgage to fund part of our early retirement needs until KiwiSaver and our other pension funds become available at 65.
I'm keen to get your thoughts on this as a strategy. There's not a lot of advice online about reverse mortgages. Do any providers make them available to the under-60s?
In some situations, I like the idea of reverse mortgages — sometimes called home equity releases.
They can let retired people make use of the hundreds of thousands of dollars they have tied up in their homes — for home maintenance, paying off a remaining mortgage, living costs or treats like travel.
I may get a reverse mortgage myself, actually. My plan is to spend my retirement savings by 90, and then — if NZ Super isn't enough at that stage — supplement my income with a reverse mortgage, so I can have a ball in my 90s!
But I'm far less enthusiastic about the idea for younger people like you.
Firstly, though, let's explain reverse mortgages to other readers. You borrow money from a bank — or other financial institution — but you don't make any repayments until you sell your home or die. In the meantime, the interest compounds.
That means that, unlike an ordinary mortgage, your loan grows. And if you live for several decades after taking out the loan — which could well be the case for you two — that growth can be scary.
Interest rates on reverse mortgages are always higher than on ordinary mortgages. That's probably because they're riskier — the bank doesn't know when it will get its money back. Costs at the start also tend to be higher, perhaps because the lenders put more time into setting up these loans and making sure borrowers fully understand them.
Over the years, different banks have offered reverse mortgages. ASB was doing it a few years back, but the main lenders now seem to be Heartland Bank and SBS.
Heartland's online reverse mortgage calculator shows what a difference it makes if you take out a loan at 60 as opposed to 90.
Let's say your house is worth $1 million and you borrow $150,000 at Heartland's current interest rate of 7.82 per cent.
If you borrow at 60, and live to 98, the loan will grow hugely — to more than 19 times as big, at $2.9 million. The calculator shows that if your house value has grown at 3 per cent a year, it will be worth a bit more than the loan, but not much.
But if you borrow at 75, and live to 98, the loan will grow much less, to just over $900,000, and you'll still have plenty of equity in the house (the value of the house minus the mortgage).
And if you borrow at 90, and live to 98, the loan will have grown to $280,000, and you'll still have heaps of equity in the house.
At 75, and especially at 90, the loan has much less time to compound. That's why Heartland will lend a maximum of only $150,000 on a $1 million house if you are 60, but $300,000 if you are 75, and $450,000 if you are 90.
You also need to keep in mind that the interest rate could well rise in future. Also, house prices might not rise as much as 3 per cent a year. All in all, taking out a reverse mortgage when you have many years yet to live, hopefully, is pretty risky.
However, there might be a way around this for you. You say you have money in KiwiSaver and other pensions. A bank might give you a reverse mortgage in your 50s on condition that you pay it back when you get access to the pension money.
It would be worth approaching not only Heartland and SBS but also your own bank, and possibly even other banks. They sometimes do one-off arrangements.
One other cheeky thought. If you're lucky enough to retire before you turn 60, how about doing volunteer work — not just for the good of others, but because research shows that giving makes people happier?
For more on reverse mortgages, read on.
It is relatively easy to plan finances for a retirement date which can be foreseen. Not so for death and the widely variable years between.
From my experience at age 89, I unreservedly recommend:
• Own your home as first priority.
• Set a date at which to run down your capital money.
• Establish a reverse mortgage for the best years that follow.
• Shop around for that mortgage. There are equivalents out there that compare favourably to those so widely advertised.
Your plan and mine pretty much match. These days, though, with house prices so ridiculous in Auckland and elsewhere, you don't have to have a home at retirement, as long as you've saved heaps to cover your retirement accommodation — whether you buy a place then or continue to rent.
A few points to note about reverse mortgages:
• Don't borrow more than you need at the time. You don't want to be paying interest on borrowed money that's sitting in a bank account.
• A warning from the website govt.nz: "If you and your partner jointly own your home, make sure both your names are on the loan document. If one of you moves into residential care or dies, the other partner may have to move out too if they're not one of the borrowers."
• Lenders usually offer a "no negative equity" guarantee. That means that even if your house is eventually sold for less than the mortgage total, you or your estate won't have to make up the difference.
• If you want to leave some money to the family, ask for "equity protection". That means that when the house is eventually sold, an agreed percentage of the proceeds can't go towards repaying the mortgage. However, this will reduce the amount you can borrow.
• It's good to get a loan that will be transferable if you move house or go into a retirement village.
For useful information from the Government about reverse mortgages, see tinyurl.com/NZReverseMortgage. There is also a good article on consumer.org.nz
I read your piece recently about the loan shark. I'm an independent financial adviser, and I thought you would be interested in a payday loan case we came across earlier this year.
We were asked by the client's employer to help sort out the employee's situation.
Fortunately, the employer was prepared to cover our costs.
We found that one of the loans was advertised as "1 per cent per day charged throughout the lifetime of the loan".
It then goes on to say that the "AIR (Annual Interest Rate) is 365 per cent pa — which seems high. However, because our loans are a short-term solution, our customers find our rates quite reasonable, especially when compared with other lenders in our industry."
The questions are:
• Is this factually correct?
• Is it "reasonable"?
My understanding of compound interest suggests that the effective interest rate is not 365 per cent a year but actually 3700 per cent a year. And if that is the case this is misleading. And of course it's not reasonable — but people don't know. What do you think?
This is the most extreme example of shark-lending we have come across.
Interestingly we asked the client if they wanted to lodge a complaint with the Commerce Commission. They said no, they didn't want to "make a fuss". I suspect that the complaints process is not really effective in dealing with bad behaviour because the victims just want to get on with their lives.
We see this happen frequently. And we don't get paid for following these up, however strongly we believe that justice has not been done.
This particular story did have a happy ending. We were able to negotiate a settlement figure well below the figure the client had been quoted. I think the lender decided that they didn't want us causing trouble.
What a great employer, what a shocking loan and what a good outcome.
Unfortunately not everyone has a boss who will rescue them from a situation like this.
And I agree that many people who borrow from payday lenders probably don't realise how bad the deal is, and are reluctant to complain when it's pointed out to them.
Hopefully the Government will come up with a better system to control this type of borrowing.
More on this subject next week.
A couple of comments on your last NZ Herald column.
Under "The tough truth about HomeStart grant", you said: "There's a bit of good news, though. As Webber points out: 'This couple may still be eligible to withdraw their KiwiSaver funds to assist with the property purchase.
'There is not a house price cap or income cap to fit with the KiwiSaver First Home Withdrawal. They do need to have been contributing KiwiSaver members for at least three years, not currently own any interest in estate and have a sales and purchase agreement identifying themselves as buyers.'"
This is not quite accurate. KiwiSaver members only need to be a member for three years to make a first home withdrawal. The contribution requirement only relates to the HomeStart grant.
And you also must not currently or have ever owned an estate of land (unless you have a determination from Housing NZ as a previous home owner).
Under "Future income", you said: "I know you're not in the KiwiSaver market, but once you've found the most suitable KiwiSaver funds, you can ask those providers if they have similar non-KiwiSaver funds. In most cases they do."
It is worth noting that a bill currently before Parliament would, if passed, allow over-65s to join KiwiSaver from July 1, 2019.
Under "Share it around", about a reader investing $200,000 directly in shares, note that the investor would be competing against professional managers.
So while buying and holding will restrict transaction costs, the investor would still need to pick an optimal portfolio of shares initially to outperform a managed fund.
You've got an eagle eye! And your first point is quite right. The expert I quoted should have made it clearer that there are no minimum contributions levels for first-home withdrawal. You just have to belong for at least three years.
But I think you're quibbling about property ownership. The expert said the couple "may" be eligible, and that could include qualifying as a previous but not current property owner.
Your mention of the proposal to let 65-plussers join KiwiSaver is good. I've written about it before, but repetition can't hurt.
On share investing, you're right. But it's not uncommon for professional managers to do worse than individual investors who buy and hold, especially after taking into account fund fees and the costs of quite frequent trading by many professionals.
Thanks for reading so closely.
- Mary Holm is a freelance journalist, a director of the Financial Markets Authority and Financial Services Complaints Ltd (FSCL), a seminar presenter and a 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, Private Bag 92198 Victoria St West, Auckland 1142. 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.
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