We are stuck with this unfortunate name tag – Reverse Mortgage. Like any mortgage it is to borrow money, but here it means you are borrowing against your equity in your home. This is what business people have always done. So what's the big fuss about? The problem emerges with the circumstances of the borrowers and their vulnerability to their own weaknesses/misunderstandings/and sometimes family and friends. To explain:-
1. It is easy to borrow against the equity in your house for an expensive holiday, new car or stock market flutter. It is not so easy to understand that compound interest (at increasingly higher rates) with little or no capital repayments will eat up that equity slowly but inevitable, unless the property market keeps going up steadily. And if/when it goes down, the eating up is quick not slow.
2. Family and friends are for sharing, right? Taking out that loan is a great way to join in the pleasure of giving / sharing. The ferryman has to be paid eventually, and as long as everyone realises that a good time now means not much inheritance later, no real harm is done.
3. People say they know what they are doing. They are consenting adults, but it is sometimes not informed consent. They only look to the next day or year, often not the next 5 or 10 years and seldom to the possibility of changes in interest rates or markets.
Half the Australian population have only known good economic times. The other half have difficulty remembering the bad ones. In the last 2 years the reverse mortgage market has doubled to $1.8 billion with more than 31,000 such mortgages in place in Australia. This is expected by the industry to grow to between $12 billion and $15 billion in 2 years. On that basis I can calculate that there will be between 200,000 and 250,000 such mortgages in 2 years.
4. Is there a problem? Well, there can be. The Australian Securities and Investment Commission released its second report "All we have is the house" Report 109. in November 2007. To be fair, its survey was based on only 29, yes twenty-nine out of the 31,000 reverse mortgages but the key findings are the indicators of where the problems lie. They include:
- Most did not fully understand how it worked.
- It is difficult to estimate the long term cost.
- It is also difficult to work out how much equity might be left to fund future needs.
- Older people may be encouraged to take out such a mortgage or to use funds in inappropriate circumstances.
5. There are moves to incorporate the issues into legislation. However the pressure points are relevant now, with or without legislation. These are the real questions:
- What are the specific features of this loan? eg. Can capital repayments be made, is the interest payable on the total loan for the total term? Is the rate fixed or variable and for how long?
- Have the next-of-kin been consulted?
- What does their accountant or lawyer think?
- Is there a non-borrower living in the home?
- Will the final debt be limited to the value of the home?
- What are the estimates or ranges of estimates of debt including interest for different periods of time?
- What are the estimates or ranges of estimates of value for the house for those different periods of debt?
- When might future aged care accommodation be needed?
- What assumptions are made for interest rate changes?
- What assumptions are made for land value changes?
6. At the moment, we live with unusual stock market volatility, rising recession worries and selected exposure to the sub-prime mortgage crisis in the U.S., a cooling property market nationally but a seemingly stable one in Townsville - memento vivere - the pleasure of living. Reverse Mortgages – part of the pleasure of borrowing, if you are careful.
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