Martin’s paraphrase of his ‘Sunday Star Times’ article, 26th April 2015, whose copyrights we acknowledge.
Last week we learned that the Reserve Bank has concerns about “reverse annuity mortgages”. These are financial products that older people buy which allow them to re-mortgage the house for cash on which to live. Banks (mostly Heartland and ASB) will lend retired people money for lifestyle purposes. Interest accrues but does not have to be paid in cash; it is added to the capital sum and the whole lot is repaid when the retiree (or her estate) sells the house.
In my view these are great products as they allow people with a valuable house to travel or replace the car. Those who are asset rich but cash poor can stay in their houses and draw on their capital. For some people, the ability to borrow cash in this way will be an excellent choice even though the accruing interest will reduce wealth.
An article posted on stuff.co.nz talked in part about the RBNZ’s concern that the banks lending money like this could have difficulties in the event that there was a house price crash. I understand the RBNZ’s concern: financial stability is important part of its remit.
Nevertheless, the “stuff” article provoked considerable comment about the desirability of these products. Much of this comment was ill informed and I am anxious that retirees and their families understand them properly. I have done a lot of work in this area including, in the past, some retirement seminars for Heartland (although I have no involvement with them now).
There were three main objections from those commenting on stuff: first, there was an objection to banks charging higher interest (about 8.3% p.a.). People should realise that these kinds of loans will always be more expensive because the lender has to wait for years to receive the interest payments in cash (i.e. when the house is sold). Moreover, the risk on these products is with the lender: if the loan ever grows to be more than the value of the house, the lender carries the loss.
Second, objectors were concerned that there would be smaller inheritances for the retirees’ families. Yes, of course that is right: you cannot have your cake and eat it too. In my view, retirees should feel no obligation to leave inheritances – the house that is being borrowed against is their own and no family member should believe that they have a right to an inheritance. If older people want to run down their capital to enjoy life, that’s their business.
The third objection was that retirees who enter into one of these products could lose the house and find themselves living on the streets. This certainly used to happen with the old style products, but now providers like ASB and Heartland are very clear that you cannot be forced out of the house or be required to make up any shortfall between the house value and the loan with accrued interest.
Although these products used to be called “reverse equity mortgages”, this is a misnomer – they are not annuities and the modern version bears little resemblance to the old type of product. These products are now better called home equity release.
Home equity release is useful for those with houses but without cash for lifestyle. Retirees have every right to use their houses (or any other asset) to give the best life possible – after all, it’s their house and it’s their life.
Martin Hawes is an Authorised Financial Adviser and a disclosure statement is available on request and free of charge, or can be found at http://www.martinhawes.com. This article is of a general nature and is not personalised financial advice.