Need a retirement top-up?
In today’s Jargonbuster we look at the different types of home equity access. This is a complex topic as there are many different types of home equity available for retirees – and each type varies in features, upsides, downsides and the ultimate cost to the borrower.
But it is an important topic as over the past decade or so, more and more Australians have entered retirement with a mortgage, rather than fully owning their own home. This means, of course, that from day one, your retirement income is going to need to stretch to cover mortgage interest repayments. You can, of course, withdraw a lump sum from your super to pay off your mortgage. But if this means you will be significantly reducing your future available retirement income, you may just be robbing Peter to pay Paul – and staring down the barrel of years of penny pinching just when you want to get out and enjoy new adventures.
Regardless of whether you are on an Age Pension or not, or whether you have a mortgage or not, there may come a time when you wish to activate the equity in your home in order to achieve certain goals. These might be related to home renovation or improvement, intergenerational transfers, extra ongoing income top-ups, or affording medical procedures or health insurance. Whilst it may be appealing to unlock this equity, it is critical that you seek advice before committing to any loan, as the drawdown of such equity can have huge ramifications on your Age Pension eligibility. Interest rates on different types of equity access loans also vary considerably, and it is easy to move from a position of owning 80% of your home today, to only half that amount in a decade or so.
What is a home equity loan?
A home equity loan is a loan which uses the equity in your home as collateral. Your equity in your home is the market value of your home, less any outstanding loans. It is this amount (‘raw’ equity) that will determine the type and amount of loan for which you could be eligible.
Types of home equity loans
The following four types of loans are the main ways Australians can currently access the equity in their homes. They have very different regulations, features and requirements, so this overview is simply to help you understand the top level differences, in order to research further detail with an appropriately qualified professional.
Line of credit
A line of credit is a loan from a bank or a lender, usually required to be repaid monthly. This is not always discussed as home equity access in the case of retirees, as getting approval for such a loan after you have left full-time work can be very difficult. There are also new minimum repayment rules in place which ensure that a percentage of the loan (which may be over and above your interest repayment amount) is covered every month. As mentioned, a line of credit may not be readily offered to retirees but securing such access to your equity might be a useful part of your thinking before you retire if you believe you can still genuinely cover repayments after you have left the workplace. Interest rates for such loans are usually competitive, i.e. in line with normal mortgage market rates.
These are loans against the equity in your home. They might appeal to many retirees as they can help unlock funds, whilst allowing you to stay in your home, without making repayments.
But there is a cost to such loans, of course. Typically, you will be allowed to borrow, depending upon your age, only a certain percentage of the value of your equity. This amount can be taken as a lump sum, an income stream, a line of credit or a mix of these types of drawdowns. The interest on the loan is then charged back against the loan, which increases over time. The loan is usually repaid upon the death of the mortgage holder or sale of the property. The income received from the loan is generally not assessable in the Age Pension unless it is invested.
Since 2012 federal government legislation has prohibited any reverse mortgage holder from having a negative debt facility. This means that you can never be caught out owing more than your home is worth. Some loans also allow you to make repayments if you are in a position to do so.
The ASIC Moneysmart website has a very useful calculator which allows you to see how your debt can increase while your equity can reduce during the course of a reverse mortgage loan. The calculator currently offers a default interest rate of 7% which is alarmingly high. At the time of writing there were reverse mortgages on offer for around 5% – which of course is still high in the current low rate environment. You can adjust the interest rate to test different outcomes.
Apart from using this calculator, it is important if considering a reverse mortgage to do your own homework as well as seeking advice from a qualified reverse mortgage professional.
This type of equity access allows you to sell a ‘portion’ of your home to an agreed provider. What you are selling, however, is a portion of the future value. A discounted amount is then made available to you based upon the agreed market value of your property today. This is a sale as opposed to a loan, so you do not pay back interest. Instead you pay a transaction and valuation fee, then when the property is ultimately sold (either by you or your estate), the home reversion provider will be owed the full percentage value of their holding, plus any remaining fees.
Again, such a loan should be considered carefully and discussed with a qualified reverse mortgage professional.
Home equity access scheme (formerly Pension Loans Scheme)
This loan scheme is offered by the Federal Government through Services Australia [ https://www.servicesaustralia.gov.au/home-equity-access-scheme ] and the Department of Veterans Affairs (DVA). Eligibility rules mean this scheme is mainly available to those who qualify for a government pension. The loan is paid in fortnightly amounts or twice-yearly lump sums which are non-taxable and intended as a supplement to existing retirement income. Equity in your home is the collateral for the loan and you can decide the proportion you will use for loan security. The loan and associated fees and costs must be repaid. This can happen while you are still in the property, when you sell the property, or if you pass away, your estate will be billed for the outstanding amount. It is possible to transfer this loan to a new property, by contacting the relevant department. Although this scheme is government guaranteed, it is still important you seek the appropriate legal or financial advice before committing.
Downsides of home equity access schemes
There are many potential pitfalls when borrowing or investing large sums of money in retirement. Home equity loans are, as explained above, very specific types of loans which have downsides as well as benefits. Some things to watch out for include, but are not restricted to:
- Age Pension eligibility
- High interest rates
- Rapid reduction in your portion of home equity
- Attracting penalties through poor use of lump sums
- Accommodation security for a surviving partner
Home equity loans such as reverse mortgages also tend to be more expensive than standard mortgages. There are several reasons for this. First, there are no regular repayments on a reverse mortgage, you only repay at the end of the loan. Second, the term of the loan is uncertain, there is no clear end date as it is up to the borrower’s personal circumstances when they choose to complete the loan and repay the principal. These factors greatly increase funding costs for the lender which the lender passes on to the borrower.
In each of the above matters it is extremely important that you do your homework thoroughly, seek relevant advice from an appropriately qualified lender as well as independent legal advice. Ensure that you have considered all aspects, including the implications for your family, of the use of your home equity to further fund your retirement goals.
You can read more about the Government’s Home Equity Access Scheme at https://www.servicesaustralia.gov.au and as always you can check your Centrelink entitlements by clicking below.
This article is provided by Retirement Essentials Representative Number: 001260855. We are an authorised representative of SuperEd Pty Ltd ABN 88 118 480 907 AFSL #468859. This information is not intended as financial product advice, legal advice or taxation advice. It does not take into account your personal situation, goals or needs and you should assess your own financial situation, consider if the information is suitable for you and ensure you read the relevant Product Disclosure Statement (PDS) if you choose to make any changes to your financial situation. It is always advisable to consult a financial adviser before making financial decisions.