26 Giffard Street
Williamstown 3016
Ph. 03 9397 7275
Fax. 03 9397 1734
Mobile. 0428 310 165
Email. reidcont@tpg.com.au
ABN: 65 111 801 079
www.reidconsultants.com.au

In our January 2006 newsletter, we outlined what Reverse Mortgage Loans or Seniors Equity Loans are, how they worked and how they converted equity in your home into cash, in the form of a lump sum payment, an "income" stream or a combination of the two. In this newsletter, we will review the ways most folk have been using the money and then raise other potential uses that could be considered in the right circumstances, including helping your children or grandchildren now .

A reverse mortgage is simply a registered first mortgage over your property, much like a normal home loan most of us have used to purchase our home. The major difference is that you do not need to pay any principle or interest on this loan. The interest is capitalised, meaning that it adds onto the loan and consequently the amount you owe grows over time. What this loan does is give you access to immediate cash funds to use as you want to and that suits your needs and circumstances.

The four determinants of how much you can borrow are:

• age of youngest borrower (most lenders require both to be over 60 years),
• the value of the property,
• who the lender is, they all have slightly different lending criteria,
• what mix of funds you require, lump sum, income stream or a combination.

The main purposes seniors are using the money accessed by reverse mortgage are renovations and upgrade of appliances; travel and lifestyle – taking that trip of a lifetime; refinance existing debt mortgages and/or credit cards; income supplement to the aged pension; medical operations rather than waiting for public lists, assist family now rather than later; paying the day to day bills; upgrading your vehicle and for the financially savvy, using it to increase your wealth by superannuation or investments.

The research by Trowbridge Deloitte showed three broad customer types

• Under financial pressure, i.e. eroded savings, relieve pressure of debt or other (divorce), immediate need
• Lifestyle consumption, i.e. to supplement lifestyle living, utilise lump sum advance for luxury or capital purchase
• Financially savvy, i.e. they largely consider their house alongside other assets, willing to run down their assets while still living, fund leverage investments to diversify assets, often higher overall wealth and higher pre-retirement income

The first group include singles and couples that are on a government pension (it is designed to be a subsistence amount) and having difficulty making ends meet. It may be that they have existing debt in the form of a mortgage or credit card debt that they cannot clear and are having to pay this from their pension and that then leaves very little to live on. By paying off the existing debt by the use of a reverse mortgage, which immediately frees up that money on a monthly basis, they are able to afford their day to day needs.

In many cases, folk have been in their home 30 or 40 years or longer and can no longer afford the upkeep. The house is falling down around them and they cannot find the capital lump sum required to pay for that new roof, or bring the outside toilet inside, or replace the porch. Taking a lump sum option, that money may be used to replace that old roof or a new stove or heating. The long term consequences may be that the investment in your home benefits you now but also benefits your beneficiaries in that your house increases in value rather than falls.

Another use that has been popular is to obtain that medical treatment that you could not previously afford and so you ended up on the public wait lists. Rather than waiting for 2 years or 5 years or longer, folk have been using the funds obtained to pay for that operation and benefiting from the increased quality of life now.

The second group include those that have promised themselves that trip of a lifetime when they retired, whether it is an overseas holiday or even the purchase of a motor home and touring Australia yet found they did not have sufficient savings to do so outside their home. It also includes that group that expected to have sufficient savings within or outside superannuation that has just not eventuated. The decrease for some folk from a full income when working down to a government pension, being 25% of average wages, is dramatic. The average superannuation balance for Australians is $75,000. This is nowhere near sufficient to provide even a modest lifestyle.

A growing use of reverse mortgages is to supplement other income, both government and allocated pensions. Obtaining an “income” stream over 5, 10 or even 20 years could make an enormous difference to lifestyle, moving from a bare subsistence lifestyle to a modest or even comfortable lifestyle. The government aged pension pays around $13,000 for a single and $22,000 for a couple per year. A December 2005 survey found that a modest lifestyle budget for a single was $17,826 and $24,930 for a couple per year and a comfortable lifestyle budget was $34,560 for a single and $46,192 for a couple.

Using the example above of a $300,000 house, both aged 70, an income stream of $625 per month for 10 years is possible. This could be higher depending on lender and it could be indexed. Imagine what benefit you could gain from having that little bit extra each month.

The third group includes those that regard their house as just another asset to be used to increase wealth. As the property market may now be in a cycle where minimum growth is predicted (or even falling values), people are looking at transferring some of the value in their property (it may be an investment property or holiday house) back into other wealth creation assets or vehicles like superannuation. Some strategies are shown below that can be used to benefit in the right circumstances.

• Over 60 and still working, an alternative to or to complement a transition-to-retirement pension, salary sacrifice into superannuation, reduce your income tax bill, build up your superannuation, yet still maintain your lifestyle using a Reverse Mortgage
  
• Under 65 and able to contribute into superannuation, consider taking a lump sum with a Reverse Mortgage utilising equity in your house and make an undeducted superannuation contribution, again building up your superannuation balance for retirement
  
• Invest in your home, renovate and improve the value using other assets currently assessed under the pension Assets test, take a Reverse Mortgage for lifestyle and potentially be able to qualify for the aged pension as well

"What will be the effect on beneficiaries " is often a question people ask. It depends predominately upon the underlying movement in the property market but also on the form of borrowing (lump sum and/or income stream), how much you borrow and the interest rate and costs. In some cases, your equity in your property may increase or be maintained. Capitalisation of interest over time will increase the amount owed on final settlement, but whether that is greater than the increase in the property market, only time will tell. What is certain is the amount you will owe, what is not certain is how the value of your property will move over time.

The concept of leaving an estate or value to your beneficiaries is an important one. However as we are living longer, it may be your children will be in their 50's or even 60's when you die. It may be that they could do with assistance now, to help fund grandchildren education or to assist with their living expenses. It could be to help provide funds for their new business start up, or to provide a deposit for their first home or even to loan money so they can pay off their mortgage and then repay you at a lower interest rate than their mortgage rate.

There are issues to consider including possible pension implications of the income and assets tests and gifting provisions. Structuring any financial arrangement, even with children, should be formalised so all parties know of the arrangement, the provisions and their rights and duties.

The real question often comes down to quality of life. Are you living the lifestyle you expected to or deserve to in retirement? Imagine what a lump sum of $50,000 or a monthly payment of $250 would allow you to do. One interesting aspect from both research and the lenders is that the children are surprisingly supportive of their parents living a good lifestyle and enjoying themselves.

Give me a call to find out whether this type of product suits your needs and circumstances and what could you borrow based on your age and value of your house. This appointment is at no-cost and is obligation free, call - 9397 7275

Helping People through Finance