If you own a house, are short on cash, and are around 60 years old, banks will sometimes agree to lend you money and only expect repayment when certain things (for example your death or the sale of the property) happen. These are called “reverse mortgages”.
Reverse mortgages are attractive options for elderly people who are asset rich but cash poor, as they do not have to make any payment to the lender, (although they can if they choose), they have the use of the money, they are able to retain ownership of their property and occupy it at the same time. Generally the applicants do not need to have any income or other assets apart from their home and will not have to pass any eligibility test. At least one major bank is now offering this type of loan in New Zealand.
The typical features of these loans are:
- There will be a minimum age for the youngest borrower which is typically 60 years old. Sometimes it is reduced to 55.
- The loan will be limited to a percentage of the value of the house. Generally the valuer will be appointed by the lender.
- The percentage increases with the age of the borrower.
- The house must be of a minimum value.
- Interest is accumulated on the loan at a variable interest rate, although fixed and capped rates are available with some lenders.
- Interest is compounded.
- The interest rate is usually a given percentage, for example 1.5% or 2% per annum above the major bank’s variable mortgage rates.
- Money may be drawn down in lump sums or by way of periodic payment.
- The principal and interest are repaid on the happening of certain events.
- Loans generally have a negative equity guarantee, that is, if at the time the loan is repaid the loan exceeds the value of the property then the lender will not pursue the borrower or their estate for the shortfall.
As in any financial transaction there are risks that need to be identified and dealt with. In the case of reverse mortgages there are a number of risks that are important to consider and that are largely unique to this type of loan.
Because of the nature of the reverse mortgage they erode equity in a property very quickly. While the property market is increasing in value, the rate of reduction of equity in the property will be comparatively slow (depending on the size of the loan and interest rate). However because of the nature of the New Zealand financial markets there are going to be periods during which interest rates are comparatively high and capital growth is going to be limited. In these situations there is a great likelihood that equity could be eroded at a significantly faster rate than may have been envisaged after the loan was taken out.
In the worst case scenario the borrower could be committing themselves to living in their existing property for life as they will not be in a position to purchase another. While at 65 this may not be a major concern, looking after the same property at 80 may be, particularly if it is a large family home with extensive gardens.
There may be other options for the elderly person to consider such as downsizing, subdividing, selling the house to family members, renting out a room, or taking in a boarder.
Reverse mortgages are a useful tool that will provide assistance to a large number of older people. However, any enthusiasm for them needs to be tempered with a frank assessment of the risks and possible other options they may have. Your legal advisor can discuss these with you .