Home advantage: Reverse mortgages

Reverse mortgages are little understood as a wealth accumulation strategy and source of credit.

The idea of taking out a reverse mortgage on your principal home was a strategy many Australians viewed with wariness and, until now, the majority of financial planners has largely ignored.

But with up to 60 per cent of Australians’ wealth locked up in the family home and with their investment assets crashing, that view is beginning to change.

In the past, reverse mortgages flew under the radar of many financial planning firms, with planners preferring more traditional avenues of wealth accumulation for pre-retirees.

Since 2005, the use of reverse mortgages as an investment strategy has been typically restricted to a small segment of retired workers who wanted a source of credit to fund an improved lifestyle in retirement, according to Kevin Conlon, the executive director of the Senior Australians Equity Release Association of Lenders (SEQUAL).

But with the financial crisis biting into clients’ investments, there is growing interest in the strategy from investors who need a source of credit to supplement their investment incomes.

“What we’re seeing emerge in the current [environment] is a broader base of consumers, even consumers that the market didn’t expect to see, and these are self-funded retirees,” Conlon said.

“Their exposure to a narrow risk space has become obvious to them and they are increasingly making enquiries as to how an equity release strategy may suit their changed circumstances.”

John Thomas, chairman of both Australian Seniors Finance (ASF) and SEQUAL, said financial planning clients, particularly super investors, are suffering from poor investment returns and planners are increasingly considering reverse mortgages to bridge the gap.

“Financial planners haven’t to date been the biggest source of reverse mortgages; [but] they are now increasingly looking at a reverse mortgage,” he said.

For an industry focused to a large extent on those approaching retirement — the baby boomer generation — a client’s home is a relatively untapped source of wealth.

Senior financial analyst at Canstar Cannex Harry Senlitonga said the baby boomer generation would retire in the next five to 10 years, and the majority of their wealth assets were locked in the home.

A Reserve Bank of Australia bulletin of household wealth earlier this year corroborated his comments. It showed that residential property accounted for 60 per cent of the value of a household’s total assets, up from 54 per cent seven years ago.

Conlon said the ageing demographic of the baby boomer generation will spur further growth in reverse mortgages as a financial planning strategy.

“It is clear that the dealer groups, if not the industry body, are recognising that their practice has to extend to serve the needs of their ageing clients.

“My belief is that reverse mortgages will form an important part of the financial services industry as the demographics start to show itself in a more obvious way than it has today,” he said.

Martin Lynch, head of reverse mortgages at Royal Bank of Scotland (RBS), said for a strategy as prone to demographics as reverse mortgages, financial planners were beginning to recognise it as within the sphere of wealth accumulation.

“Aged care planning tends to be something that financial planners see as their bread and butter,” he said.

However, Lynch noted that the greatest number of users of reverse mortgages were about 74 years old, and the expected interest from baby boomers was still some years away.

“The number of people aged over 80 in Australia doubles in the next 15 years, so that’s when the growth is going to soar.”

Lynch also attributed increasing interest in reverse mortgages to aged care facilities, which were becoming more aware of the strategy for future residents.

In the past, those heading for aged care accommodation typically sold their homes to pay for their entry into, and costs of, the facilities.

With the increasing use of reverse mortgages, potential clients could utilise a reverse mortgage product to purchase an accommodation bond for an aged care home without making a decision to sell their home.

Education and awareness

Despite the increasing interest, there is a lack of awareness and education among both consumers and financial planners about how to use reverse mortgage products.

Paul Intagliata, a financial planner at Aged Care Financial Services, said criticism of reverse mortgages in the media stemmed from a lack of information about what sort of clients were suited to the strategy.

“I think, in general, there’s been a lot of inaccurate information put out in the media over the last three or four years about reverse mortgages,” Intagliata said.

“For the right person who gets the right advice, they can certainly be a valuable asset as part of a package to help with retirement or aged care. But the important part is the advice — they’re certainly not suitable for everybody. People need to plan correctly in utilising them,” he said.

The Australian Securities and Investments Commission (ASIC) warned earlier this year of the misuse of reverse mortgages, and released research showing that consumers found it difficult to understand home equity release products.

At the time, ASIC chairman Tony D’Aloisio said while equity release products offered benefits, there were also significant risks, including consumers being encouraged to borrow more than they needed against the value of their house.

However, ASIC based its research on data from 2005, and possibly even earlier, according to Lynch.

“I had presented to [the regulator] hard evidence that people are using reverse mortgages wisely and borrowing what they need, rather than what they qualify for,” Conlon said.

Research from RBS revealed that consumers were only borrowing up to 17 per cent of the value of their home when they qualified for a loan of up to 30 per cent, he added.

Despite this apparent wariness, Conlon said there was a poor level of understanding among financial planners about the nature of reverse mortgages.

“I worry about the risk of a financial plan reflecting the preferences of the adviser rather than the client. Much of what I have heard in financial planning forums has been opinion based. The fact is they’re not even considering the family home as existing exposure to property.”

Industry consultant Paul Resnik said the suitability of a reverse mortgage depended on the client’s circumstances.

“It is always better to do things knowing the consequences. In the hands of a good adviser who understands how clients’ needs or circumstances change over time, it may be a good idea or a bad idea,” he said.

“We don’t sneer at downsizing the house; somehow we sort of sneer at reverse mortgages, as if there’s something inherently bad about them,” he added.

Credit crunch

One of the issues financial planners face if they recommend a reverse mortgage to a client is the tightening credit environment.

“It’s very difficult. Virtually no provider is able to get unlimited funding [at the moment],” Thomas said.

“Some providers are not writing any business, some providers have gone out of the business, and most providers are limiting their lending.

“It’s affecting the [reverse mortgages] sector fairly dramatically,” he said.

Eight reverse mortgage lenders have withdrawn from the market in the space of six months to January this year, according to research released by Canstar Cannex, with many reverse mortgages falling victim to funding shortfalls.

Intagliata said lenders had become stricter in approving certain loans.

“We’ve certainly seen a bit of tightening of LVRs [loan to value ratios] of certain loans that perhaps 12 months ago would have been fine, and now there’s been a reduction in the amount of money [for loans].”

Across the board, most mortgage providers have been “pretty rigid” in terms of their LVRs, with lenders only willing to lend up to 40 per cent of the value of the house, he said.

Lenders may look at loosening that down the track, but it’s too hard to determine if that would be the case, Intagliata added.

According to Senlitonga, both banks and consumers are taking on risk because of the compounding effect of the interest on the loan without repayments from the borrower.

Reverse mortgage lenders may be willing to lend up to 30 to 40 per cent of the value of the house, but no higher than that in the current environment.

According to Senlitonga, current property prices and interest rates are factors that financial planners will have to take into account.

Lenders factor current property prices into loans, so any change in property prices was an important issue for lenders to consider, he said.

However, lenders typically look at house prices over a 10 to 15-year range as the basis for their pricing models, he added.

But, according to RBS’ Lynch, the property sector did not affect reverse mortgages “particularly significantly”. While lenders’ valuations were conservatively estimated, which would “ruffle a few feathers”, as long as borrowers were getting the amount of money they needed, there was no reason they would be concerned, he said, adding that the average LVR of his bank’s customers was approximately 18 per cent.

He also believed that because LVRs were so cautious in the current market, the risk from rising interest rates and house prices was negligible.

SEQUAL’s Conlon believes the “key issue” for consumers is that the market remains liquid.

He said the real risk was to the level of competition and the benefits that flow to consumers from the competition.

Despite the issues the sector is currently facing, Conlon believes it will recover and expand.

“I do think this is a market worth watching,” he said.