KEY POINTS:
The elderly should wait until age 70 and borrow only small sums against their homes, says the public issues committee of the Auckland District Law Society.
Retired people are vulnerable to the pitfalls of the growing markets in reverse mortgages and need to fully understand what they are getting into, the committee says in a discussion paper.
Reverse mortgages, the most prevalent form of home equity release, 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 sold. Typically, interest is calculated at 1 per cent to 2 per cent above mortgage rates.
The committee gave examples of loans taken out for $30,000 and $100,000 on a house valued at $280,000. Compounding interest would increase the $30,000 loan to $467,838 after 25 years and leave $278,596 in the property. The $100,000 loan would increase to $1,559,459 after 25 years and eat up the equity in the house after 10 years.
At first glance, reverse mortgages seemed an ideal way for the elderly to maintain independence and provide cash, but they should only be approached with great caution after understanding all the issues, the paper said.
"The conservative would say they should be avoided at all costs as compounding interests makes them extremely costly and could see the family silver disappear.
"Unless the borrower is over 70 years of age and intending to borrow only a small proportion of their equity, they should be very circumspect about entering into such a mortgage."
The paper comes as a new code of practice governing the reverse mortgage industry looks set to become law.
Retirement Commissioner Diana Crossan this month recommended that a code being developed by the Office for Senior Citizens should become law next year.
It is likely to stipulate a number of measures, including a "no negative equity" to stop the owner or their heirs being left in debt; a guaranteed lifetime occupancy for the mortgage holder; compulsory information on how much the loan will grow over time; allowing loans to be transferable to a retirement village; and making independent legal and financial advice compulsory before taking out a reverse mortgage.
There is strong support from the industry and the Law Society for lawyers to provide clients and their families with independent advice.
Vaughan Underwood, chief executive of Sentinel and chairman of the industry body Sherpa (Safe Home Equity Release Products Association), said he "totally agreed" with the committee's view on reverse mortgages and supported the draft code becoming law.
Mr Underwood said the average age of Sentinel clients was about 73. The company advised prospective clients to exhaust other assets before taking out a loan on their houses at higher interest rates. It also discouraged people from borrowing against their homes to invest.
Mr Underwood said Sentinel, with about 77 per cent of the reverse mortgage market of about 10,000 loans, did not believe independent financial advice should be mandatory but it should be mandatory for it to be offered.
The vast majority of the elderly were bright and could educate themselves quickly to make a good decision. Only a small number of elderly were exposed to a good sales story, he said.
The paper said there were cheaper alternatives to reverse mortgages. They included Government loans against houses for rest home residents, similar loans by the owners of some retirement villages and some councils allowing rates and lower interest charges to accumulate until the death of the owner or sale of the house.
