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

1st April 2008

This newsletter explores whether and how a reverse mortgage fits into a self funded retiree's financial strategy. A reverse mortgage is a type of loan which is secured by property. It is specifically designed for seniors, generally 60 or older who own their own home. As for a normal mortgage, the lender takes possession of the title (it remains in your name) and registers a mortgage over the property. The difference between this and a normal loan is that principal or interest does not need to be repaid during the normal course of the loan. The loan is repaid when the home is sold, permanently vacated or on death of the last borrower.

• Under financial pressure, i.e. eroded savings, relieve pressure of debt (existing mortgage or credit card debt) or other (divorce), immediate need to buy basic necessities or replace essential household appliances
• Lifestyle consumption, i.e. to supplement lifestyle living, use a lump sum advance for luxury or capital purchases
• 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

Self funded retirees fall into the latter two customer types, where a reverse mortgage may be used for capital or luxury purchases or used jointly with other financial assets as part of a strategic financial plan for long term advantage.

The reverse mortgage product has advanced significantly in the last two years in particular in both choice of providers and in the product options offered. No longer is the prime lender just one bank nor is a lump sum at a variable rate the only option offered. There are over 20 lenders in the market and the choice of products is large. They vary from a simple 25% lump sum only for anyone over 65 years to at least one borrower over 60 and a choice of receiving funds as a lump sum, an income stream or a flexible draw down reserve, or a combination of them all. The interest rate can be variable, fixed for 1, 5, 10, 15, 20 years or life and there is an offering of a variable rate with a cap. Some lenders offer a protected equity option of up to 20% and SEQUAL (a not for profit lender body) lenders offer a no negative equity guarantee, meaning that the borrower will never owe more than the net realisable value of the property. Some lenders will allow use of a holiday home or an investment property to be used as security. Some lenders are post code restricted, where others will generally lend anywhere in the country.

There have been variations of a reverse mortgage developed, an accommodation bond is one of these, specifically designed to provide finance for entry into an aged care facility. A further use may be to provide home care, paid on an annual basis.

There are a number of ways that self funded retirees may consider using a reverse mortgage:

• As a supplement to an allocated pension . With the recent share market falls of over 20% this year having occurred, this has significant consequences to the asset base of an allocated pension. It may be wise to reduce the pension payment down to a minimum level to preserve capital and supplement using an income stream from a reverse mortgage. This use may also alleviate the need to ‘fiddle' with the investment strategy to chase higher and higher returns by making riskier choices that may backfire.
• Use as seed funding for other investments . An example is where a lump sum is drawn down and used as a deposit of 20 to 25% for a development project. In essence it is liquid free money as no principal or interest needs to be repaid and a development proceeds where it may not have otherwise.
• Use to diversify into other growth assets . It may be a $1m home is in an area where capital growth is now only expected to be minimal for the next period of time and alternative attractive investment vehicles moving in different cycles may be funded using some of that equity.
• Invest in your home . The home has very favourable tax and pension exemptions. It may be wise to consider investing further into your home by liquidating other financial assets like superannuation or savings that are assessable and converting this into home improvements. Government aged pension entitlement may now exist or increase and a reverse mortgage can then be taken as an income stream to supplement that pension. An income stream from a reverse mortgage is not regarded as assessable income from the ATO perspective and will generally not be assessable by Centrelink either.
• Strategic asset use . The home is often the largest financial asset we have, so accessing some liquidity in that asset may be a wiser decision than running down other financial assets and thereby reducing diversification benefits.
• Normally understood uses such as upgrading to a new trouble free car, or to take that long promised holiday or even for medical reasons to fund a hip replacement without waiting seven years or longer on public wait lists

For those nearing retirement, possible strategies include:

•  Over 60 and still working, an alternative to or to complement a transition-to-retirement pension, make a salary sacrifice into superannuation thereby reducing 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

What is sometimes underplayed by financial commentators who do not understand the mechanics of the product, equity is generally maintained if the underlying property market increases by about 4% per annum, at least until around the 18 th year, after that interest compounding starts to accelerate.

It is important that the reverse mortgage product is structured to match the need and that amounts borrowed are minimised and lump sums only taken as required. Independent legal advice is required by all lenders and some lenders will require independent financial advice as well. It is always suggested that a Centrelink Financial Services Officer be consulted so an understanding of aged pension entitlements is obtained.

The decision to consult or notify children or beneficiaries is yours to make and most lenders will recommend that you do so, perhaps to minimise their risk in the future but also to allow an opportunity to seek alternative options of finance.

An alternative to the reverse mortgage product that may suit come seniors is the Homesafe product, generally known as the Bendigo Bank Debt Free Equity Release. This is a partial sale of your property, essentially a deferred real estate sale. For people wanting a larger lump sum amount and more certainty as to what equity will remain, this should be considered.

Seel professional advice from a specialist in the area, preferably a Fortus member who is SEQUAL accredited. They work in the area day to day and understand the products and the options and have access to a panel of lenders and who follow a Charter or Code of Conduct.

Give me a call to find out whether this type of product would work for you and what could you borrow based on available cash flow and value of your property. We will work with your accountant or advisor to structure a solution that suits your needs and circumstances. We take the approach of looking at your long term goals and working to find a solution through finance for you. This appointment is no-cost and is obligation free, call – 03 9397 7275