We’re now more than two years into this cost-of-living crisis, and I’m repeatedly being asked two questions.
The first is from the asset-rich 55+ age group who are struggling to make ends meet. The question is: what is a reverse mortgage and should we use one to ‘cash out’ some of our equity?
The second question I’m asked is: will a reverse mortgage reduce what I’ll get in the will? And that question comes from adult kids in the hope of a decent inheritance.
The answer comes down to the initial money withdrawn and the cost … however, what happens to property prices after that plays a big part.
Can a reverse mortgage actually protect my inheritance?
To back up for a sec, let’s look at what a reverse mortgage is …
A reverse mortgage is a loan against a home that requires no repayments until that home is sold or is no longer required.
Your age at the outset will determine how much equity can be released via such a loan. The older you are, the more funds can be withdrawn.
My tip here is if you are taking out a reverse mortgage, by withdrawing as little as possible, as late as possible, it can preserve as much as possible of the property’s value … and that means protecting any inheritance.
That’s true under any conditions. But how the economy is shaping up will also matter.
How do economic conditions impact inheritance?
Interest rates
The first ‘economic’ unknown with a reverse mortgage is the interest rate – usually a reverse mortgage will have a variable rate, so if official rates go higher, so too will the debt that rolls up against the property.
There are no periodic repayments required, so the interest rate is always higher than a ‘regular’ variable rate mortgage.
Naturally, the debt will grow over time based on that rate. But, rest assured, the debt can’t overtake the value of the property and leave you with a bequeathed debt.
The government introduced a thing called a no-negative-equity guarantee more than a decade ago now, to stop reverse mortgage debt forging above a property’s value.
Families will want rates to stay as low as possible to keep as much equity as possible … or see if a fixed rate is available to contain the impact.
Of course, the other perfect economic condition for heirs’ wealth is …
Rising property prices
It helps hugely to preserve an inheritance if the value of the property is growing faster than the reverse mortgage debt.
Check out this example that assumes you wait a while – until age 70 – and then take out the typical maximum at that age on a $700,000 home: $210,000 (or 30 per cent).
Here’s what happens to the house and debt values, if property price growth is 3 per cent and the interest rate 8 per cent (a fairly standard rate for today).
$210,000 taken from a $700,000 home, at age 70
What happens if property prices only grow 3 per cent a year?
(Source: MoneySmart.gov.au reverse mortgage calculator)
So, you can see the initial 30 per cent, $210,000 cash withdrawal ends up consuming 64 per cent and $694,454 of the property’s value, by the time you’re 85. Don’t miss that, for your kids, there is still $396,124 left at that stage.
But look at how the numbers – and your inheritance – change at that same 8 per cent reverse mortgage interest rate if house prices instead enjoy great growth: 10 per cent a year.
The $694,454 debt only represents 24 per cent of the property’s value (from 30 per cent at first) – and there is now $2,229,620 of equity left for your heirs.
$210,000 taken from a $700,000 home, at age 70
What changes if property prices grow 10 per cent a year
(Source: MoneySmart.gov.au reverse mortgage calculator)
Naturally, the wealth wildcard that is the property market is where the no-negative-equity guarantee gets doubly powerful. Even if property prices plummet, a deceased estate will not end up owing money (and the property owner cannot be evicted ahead of that stage).
The best-case scenario for you, though? Rampaging real estate.
Will your parents spend the lot or save to pass something on?
Many retirees intend to SKI – as in, spend the kids’ inheritance. And, having worked hard their whole lives, can we really begrudge them?
But some retirees will happily prioritise leaving money to their younger generations.
What about aged care?
It’s important to bear in mind that the other whole-of-family consideration with a reverse mortgage is the potential need to fund aged care down the track.
One of the pitfalls of a reverse mortgage is that it can erode – as you’ve seen above – the equity that’s left in a property to secure an aged care spot.
Aged care is a complex area but, basically, you’ll need a lump sum to buy an aged care position. The average is $500,000. Alternatively cash flow will be needed to rent there.
As with any type of shopping, there are top-end, top-priced options.
There can, however, be government assistance available for people with lower assets and income.
When it comes to a reverse mortgage, a multiplicity of factors can make the difference – to parents and children.
If you’re concerned about how a reverse mortgage may impact your family’s inheritance, start by having an open and honest discussion with family members. You never know what this could mean down the track financially for your future.
Also read: Reverse mortgages making a comeback
Financial disclaimer: The information contained on this web page is of general nature only and has been prepared without taking into consideration your objectives, needs and financial situation. You should check with a financial professional before making any decisions. Any opinions expressed within an article are those of the author and do not specifically reflect the views of YourLifeChoices.
Perhaps we should look at a more common example of a reverse mortgage – lump sum, income stream and Line of Credit
Using a facility of $208,000, with $50,000 at the start, an additional income of $600 per month for 15 years, and a Line of Credit drawing $12,500 in years 3, 6, 9, and 12. (same 8% interest and 3% growth)
At the end of 15 years, there would be $620,118 in net equity, noting interest is charged on the funds accessed. Most borrowers have a combination of uses, unless they need a lump sum to pay off an existing mortgage.
If you use the same borrowing but against a property valued at $1,500,000 and growing at 5% annually. the net equity after 15 years would be $2,647,325.
As we saw in the 2020 Retirement income Review, there are 3 Pillars of retirement income
– Superannuation, Age Pension, Personal investments (including Home Equity).
Older Australians should be able to use any/all of the 3 Pillars to achieve their needs.
PS – Re Aged Care – no aged care facility can force a resident to pay a lump sum for accommodation – there are other options. In 2029 the Government will review the current system of paying for accommodation, with a view that everyone pays daily by 2035.