An income stream in the family home

SUMMARY: Reverse mortgages are likely, eventually, to become a mainstay of retirement planning.

The day is coming when governments will declare that the family home is no longer sacrosanct when it comes to receiving Commonwealth benefits.

That is, if you have a $2-million-plus, debt-free home, you won’t be able to (potentially) claim a full government age pension, as you can do now.

When that day arrives, those with singificant equity in their homes will be expected to draw on that to help fund their lifestyle.

And “reverse mortgages”, currently nothing more than a cottage industry, could become a mainstream product.

These equity draw-down products are already growing. Australians are increasingly tapping the equity in their homes to help fund a better retirement (often to the chagrin of their children, but that’s the kids’ problem).

For most, the home is the single largest asset at retirement and is a source of wealth created over a lifetime of working. But it provides zero income. Why shouldn’t it be drawn on to provide an income stream in retirement?

When weighed up from a costs perspective, it can be a viable alternative to downsizing. Downsizing entails selling a home and incurring the selling costs of agents’ fees and advertising costs, then stamp duty on the new pad.

If you’re selling a $1 million dollar home, you can expect around $25,000 to $35,000 in sales costs. If you’re downsizing to a $700,000 property, expect between about $8,000 to $37,000 in stamp duty (depending on a number of factors, notably which state you live in and whether you’re an eligible pensioner).

That’s a lot of money to “blow up” to switch a home. And despite the interest rates on reverse mortgages being high, at around 7%, it would take a lot in the way of higher interest charges to make up for $30,000 to $70,000 in change-down costs.

Already the home is “under attack” from this potential outcome. In this year’s Commission of Audit report to the then new Abbott Government, it was suggested that Australians with homes worth above $750,000 for couples (and $500,000 for singles) be counted under means testing for eligibility for the age pension.

If this were adopted, reverse mortgages might be the only option for some. It might become complimentary to super and age pensions.

A reverse mortgage allows you to tap into the equity of your home, slowly drawing down on that equity to fund lifestyle – the reverse of an ordinary mortgage.

A reverse mortgage allows you to start with a small loan that grows over time. Over time, the loan compounds with interest, as you neither have to repay principal, nor the interest.

A major mental hurdle for Australians is the loss of equity in the home, though this is more often than not a bigger problem for their progeny, who fear losing their inheritance.

Under current rules, the family home is exempt from tests when it comes to eligibility for the age pension. You could literally have an unencumbered $10,000,000 home and still receive the government age pension, if other assets and income streams fell under the permitted levels.

However, if someone had a modest $300,000 home, but had ploughed considerable savings into super, which had taken them over the assets-test thresholds, they could find that they receive a lower pension, or none at all.

Australian governments have taken a cautious legislative approach, particularly in regards to promises of “no negative equity”. That is, if someone borrows enough, and lives long enough, that the reverse mortgage loan is worth more than the value of the home, the bank will have to wear the difference. That is, the home is worth $700,000, but the loan, at death, is at $750,000, the lender would have to wear the cost of the $50,000 of “negative equity”.

Banks aren’t stupid. They have developed modelling and processes which means they will rarely have to wear any negative equity. The main risks surrounding negative equity in a home for banks are actually in regards to a severe property crash.

Australian may have to, eventually, accept that drawing down on home equity will become a necessity of planning for retirement. Spend a lifetime working to pay off a home, then draw down on the equity in a (mostly) still increasing asset value, to allow you to keep up your lifestyle.

Reverse mortgages allow people to live in their home until they die. They can, effectively, unlock an equity stream, or annuity, for someone in retirement.

They can be useful to people in the right situation now. But beware, the Commission of Audit recommended the home value be taken into consideration by 2027 … and if holes keep on being blown in government budgets, it might become a reality sooner than many think.

*****

The information contained in this column should be treated as general advice only. It has not taken anyone’s specific circumstances into account. If you are considering a strategy such as those mentioned here, you are strongly advised to consult your adviser/s, as some of the strategies used in these columns are extremely complex and require high-level technical compliance.

Bruce Brammall is director of Castellan Financial Consulting and the author of Debt Man Walking. E: bruce@castellanfinancial.com.au