Shifting gears on home equity

Kathy Bowler

While many financial planners regard reverse mortgages as something akin to the work of the Devil, attitudes are slowly changing.

Some advisers are starting to view these products in a new way and are considering the strategic planning opportunities they open up.

ABN Amro head of reverse mortgages Martin Lynch sums up the shift in attitudes.

“There are still some planners who take it as an insult to have to consider a reverse mortgage, but now some are considering it,” he said.

“It is slowly shifting away from the attitude of the product being a bad thing.”

Lynch believes as the product evolves, planners are overcoming their distrust.

“It’s going to be something people need to understand, as a large group [of Australians] do not have sufficient super balances to fund their retirement… Demographically you cannot ignore this product.”

The shift in attitude is illustrated by the latest research, which shows reverse mortgages continue to increase in popularity.

The most recent Reverse Mortgage Study from the SeniorAustralians Equity Release Association of Lenders (SEQUAL) and Trowbridge Deloitte found the market at June 30, 2007, consisted of more than 31,500 reverse mortgage loans with total outstanding lending of over $1.8 billion.

In announcing the figures, Trowbridge Deloitte partner James Hickey noted the growing importance of reverse mortgages to advisers as a retirement planning tool.

While mortgage brokers currently sell 44 per cent of all new loans, planners are now responsible for close to 9 per cent of all lending in the area, compared to very little 12 months ago.

“The continued involvement of financial planners is critical to ensuring the reverse mortgage market emerges as a genuine retirement product option for Australians,” Hickey said.

Sequal executive director Kieren Dell agreed.

“Financial planners are starting to see that reverse mortgages offer lots of opportunities to help clients.”

According to Paul Resnik from Paul Resnik Consulting Group, the view among planners is something of a reluctant embrace.

“The attitude is pretty much that you need to know about it, but it is not in the primary armoury of tools for using with clients.”

Bluestone Equity Release chief executive Peter McGuinness believes advisers are yet to fully appreciate the usefulness of reverse mortgages as a planning tool.

“Financial planners are slowly getting up to speed on what is a quite empowering strategy. In the next few years they will come up with a few really practical strategies for use with these products.”

Lifestyle or financial asset?

In part, the change of heart among planners reflects a new attitude towards the inclusion of the family home in clients’ financial plans.

“There is a shift in planning to start looking at the home as an asset,” explained Dell.

“Now planners are realising the home is both a financial and a lifestyle asset.”

As McGuinness explained: “The home represents an average of 70 per cent of the net assets of retirees, so it is a significant component of overall wealth. It seems reasonable for the home to become a fairly permanent feature of retirement planning.”

Lynch is also seeing planners move towards regarding the home as a financial asset.

“It is now part of proper holistic financial planning and it is important to use all the assets that are there.”

Dell believes the home should be considered in a retirement plan from the very beginning, rather than when all other assets are exhausted in late retirement. “A bit of forward thinking is required.”

This change in attitude was given more impetus by the September 20, 2007, changes that left retirees’ homes as the only investment still fully asset test exempt.

Some commentators have gone so far as to predict those soon to retire may consider selling their existing homes and then using their retirement savings to buy a better home and gain access to a larger age pension. A bigger reverse mortgage against a more valuable home could then be used to supplement the retiree’s income needs.

Reassessing asset allocations

While this type of strategy may never become widespread, considering the home as a financial asset does require planners to take a more sophisticated approach to portfolio management for retirees.

For many retirees, the traditional approach has been to run down income stream assets such as allocated pensions and then go on the age pension, leaving the home untouched. But this strategy is being re-evaluated.

“A number of financial planners are subscribing to the view of looking at the home as part of the overall asset allocation,” Dell explained.

“Effectively, it is now a more liquid asset and that changes the asset allocation.”

McGuinness believes advisers need to discuss portfolio diversification with their older clients.

“Using other assets and not the house leaves a client’s portfolio very concentrated in property,” he said.

“A reverse mortgage helps maintain the asset allocation. The home is often excluded from the discussion, but the planner should be discussing how this asset will perform over the next few years and balancing that with the other assets.”

According to Dell, the newer approach is to run down the allocated pension more slowly and supplement the income with equity drawdowns from the home. This maintains a better balance in the portfolio’s overall asset allocation.

Lynch agreed it may make more sense to drawdown on the home if good returns are being generated by existing superannuation assets.

He also points out this approach may make the retention of some clients in run-off mode a more attractive proposition for a practice.

“It can change the category of a client as it radically changes their asset base.”

Fiduciary discussions

While reverse mortgages may create some interesting strategic opportunities, there are other considerations.

As Resnik notes: “Financial planners are more open to the idea, but it is an uncomfortable space. It seems to be full of moral hazard.”

He believes advisers need to discuss with clients the slow change in the ratio of their superannuation to property assets over their retirement and present them with options at an early stage — while choices can still be made.

“You must explore these options with them,” Resnik said.

He believes if advisers have a fiduciary relationship with their clients, then they “should be talking about these issues”.

“An awful lot of clients should receive education about this, even if they don’t take it up,” Resnik argued.

To assist advisers working in the area, CPA Australia and Sequal have released a Guidance Note for Advising on Reverse Mortgages. This guide is designed to set best practice standards and provide assistance in determining whether an equity release product is appropriate.

CPA Australia financial planning policy adviser Kath Bowler believes some of the key issues for planners are unrelated to technical and product features.

“With reverse mortgages a lot of it is emotional issues,” she said.

These products can help maintain a comfortable environment for clients, particularly those only a few years away from aged care.

“Reverse mortgages allow them to reduce stress and stay home as long as possible,” Bowler explained.

Dell agreed. “Ageing in place can be an important psychological thing... Having to sell can be devastating for older people and moving can be very stressful, so reverse mortgages can help avoid that.”

And with the transactions costs in selling a home often 5-10 per cent of the asset value, the financial impact is considerable.

“The cost of selling and buying is not insignificant,” he notes.

Lynch agreed reverse mortgages can provide an important tool for assisting older clients manage their finances.

“It allows older people to retain control of their lives.”

However, Bowler urges planners to consider all the options before recommending a reverse mortgage.

“Where these products are criticised is where other opportunities are not explored and other sources of funds not considered first.”

Dell agreed. “Financial planners need to help clients weigh up the options for funding their retirement.”

He believes planners may even leave themselves open to claims of failing to consider all the options if they refuse to consider these products.

“Reverse mortgages are about giving people more options.”

Age and health considerations

In its advice to consumers, the Australian Securities and Investments Commission is keen to highlight some of the practical considerations around taking out a reverse mortgage.

Its website warns: “A financial decision to meet your needs at 60 can look very different at 75, when your needs and circumstances may have changed significantly. These products can be complex and involve anticipating your long-term needs, including how long you think you might live and what your health or care needs might be in the future.”

Dell agreed consideration needs to be given to the latter years of retirement and believes planners must get clients to think about this issue.

“People get to retirement but they don’t think about 20 years away. It is the planner’s job to get them to think ahead.

“There is a huge role for financial planners to help people through the maze.”

In Bowler’s opinion, taking out a reverse mortgages is more than just a financial decision.

“Health and age are very important aspects of this and need to be considered carefully with the client.”

For example, the substantial cost of aged care entrance bonds need to be included in a financial plan, and this is one area where reverse mortgages can be invaluable.

“Reverse mortgages can be used so the home doesn’t have to be sold,” Dell explained.

With the average accommodation bond in NSW running at well over $200,000, mortgage providers are launching products designed to assist clients fund this major expense. Both ABN Amro and Bluestone offer these, with an option to ‘ring-fence’ 25 per cent of the home equity also available.

According to McGuinness, reverse mortgages create options in this situation.

“Transition to aged care can be traumatic and selling the home under value just to get the finance for a bond is inappropriate,” he explained.

“A reverse mortgage provides a transition facility to pay for the bond and provide time for better decision-making.”

When it comes to younger clients considering a reverse mortgage, planners need to discuss the long-term implications of redrawing equity.

“These products are long-term and usually structured not to be paid back, so if you have a younger client, you need to consider the long-term,” Bowler explained.

“You need to think through everything that could happen. Going too early can be a mistake, as the client may need these funds later for aged care.”

Flexible features

Product innovations such as fixed rates and instalments payments are also improving the usefulness of reverse mortgages.

Flexible drawdown facilities allow advisers to develop comprehensive planning approaches, with the latest Trowbridge Deloitte survey indicating 15-20 per cent of withdrawals are now income streams.

Dell believes this innovation has created a new tool for planners.

“They are useful if you are looking to smooth-out cash flow so there are not big dips when assets such as an allocated pension run out.”

Small, regular drawdowns also minimise interest charges.

“If taken in smaller amounts, you are not building up compound interest,” Dell explained.

“You can use it quite flexibly.”

Lynch believes planners are yet to fully appreciate the potential of this innovation.

“It sits there incurring no interest. It’s like a ‘rainy day’ facility and provides a stress reliever for clients, so they don’t need to go to the bank to ask for money.”

McGuinness agreed.

“It creates a significant safety net for the client without having to tap into their income facility.”

Flexible drawdowns also minimise the impact on social security benefits.

As the Guidance Note points out: “If more than $40,000 is borrowed and not immediately spent, it is then counted as an asset under the asset test. It is also classed as a financial investment and subject to deeming under the social security income test”.

According to Lynch, flexible drawdowns get around this problem.

“You can get it when you need it, so Centrelink is not interested.”

McGuinness believes this facility is an important innovation for planners: “It sits more naturally in their toolbox, as it seems just like an annuity.”

Taking small amounts as an income supplement ensures that as the client ages, they can still access additional borrowings to pay for health costs or aged home care.