Reverse Mortgage – Home Income Plan

Reverse Mortgages are not popular – Geoff Dunsford suggests some improvements to the product.

The Green Paper, launched by the Institute on March 13, put forward a reverse mortgage as one option for retirees with equity in their homes to supplement their income.

It was noted that, despite their having been around for many years, and arguably having merit for many retirees, these products have largely been rejected. One reason would be that some retirees would see their home equity as needed for ultimately moving to a retirement home.

However, the reverse mortgage could be useful for many and have appeal if the product was more attractive.

Changing your mindset

Reverse Mortgage provides a lump sum – not an income

The standard reverse mortgage provides a lump sum to be invested to provide an income. However, this would be included in the Means Test and could result in a reduction in the Age Pension payable. (The Green Paper suggests that, to encourage the use of reverse mortgages, the government could exempt the asset and income arising from the investment of the lump sum). It was noted that one provider allows the taking of the reverse mortgage proceeds in installments. However, the minimum instalment is $20,000 – rather lumpy to be considered to be “income” for many retirees!

Reverse Mortgage demands up to 2% pa higher interest

The reverse mortgage together with accumulated interest may end up only be repaid on the death of the home owner – and possibly when there is a downturn in the property market. Interest rates may rise during this period. The provider must stand any loss if the debt exceeds the sale value of the property.

In the light of the guarantees being incorporated in the product, there is an interest margin over the normal home mortgage rate of up to 2% pa.

Small loans should require a lower interest margin

At age 65, the maximum loan available is around 20% of the home equity. If say, the applicant only required a loan of 10% of the equity, the risk to the provider of the accumulated debt ultimately exceeding the equity is clearly very much smaller.

Arguably, such a loan needs a lower interest margin over the standard mortgage rate – perhaps none at all in this case.

Home Income Plan

Retirees need a product which provides a monthly drawdown of the mortgage proceeds. As drawdowns of a loan facility the payments are not taxable nor assessable under the Means Test.

The guarantee cost can be reduced – say by limiting the drawdowns to a low percentage of the equity paid over 5 years. The position would then be reviewed at the end of the 5 year period, for the purpose of assessing what could be paid over the next 5 year period.

During the first 5 years, there is little risk to the provider, so that a normal home mortgage interest rate could apply.

And maybe this would be the case also after the review for the next 5 years.

Example:

Retiree Couple:  youngest age 65; Home Equity $2,000,000

Reverse Mortgage lump sum available: 20% = $400,000;

Reverse Mortgage current interest rate 6.75% pa.

Home Income Plan:

$ 4,000 per month drawdown for 5 years; total drawdowns $240,000; current interest rate 5% pa.

After 5 years, let us suppose the Home Equity has increased to $2,500,000; there have been no changes in interest rates; hence the accumulated debt is $272,000.

Provider reassessment: The youngest retiree is now 70. The lump sum reverse mortgage that could be provided is now 25% of the equity, ie $625,000 – well in excess of the debt of $272,000.

The issue: Is there sufficient margin to cover another 5 years of $4,000 per month drawdowns?

Here the provider must take a conservative view – using statistical models for future experience of interest rates, longevity and property values.

Let us assume for the purposes for this example that the result is equivalent to assuming no growth in home values and interest rates averaging 7% pa over this period.

Conservative Forecast at 10 years

Home value: $2,500,000; debt accumulates to $667,000

Reverse Mortgage available (assuming current rules apply) for couple youngest age 75 is 30% of $2.5m = $750,000.

Decision

So OK to provide another 5 years of $4,000 of monthly income with normal mortgage interest rate applying to the accumulating debt.

After 10 years, let us suppose the actual home value has increased to $3,000,000 and there have been no changes in interest rates. The accumulated debt is now $619,000.

Lump sum reverse mortgage available for the couple, youngest age 75, would be 30% of $3m, ie $900,000 – so that the accumulated debt is well covered.

So total drawdowns provided have been $480,000 – usefully in excess of the original $400,000 maximum lump sum reverse mortgage available. The debt has accumulated at 5% pa rather than the reverse mortgage rate of 6.75% pa, and the provider will have achieved normal mortgage profitability, having taken minimal risk. (The administrative cost of making regular drawdowns is unlikely to be any more that crediting mortgage repayments – and occasionally needing to chase them).

Further Reassessment

Calculations show that the provider would be unlikely to agree to another 5 years of $4,000 of monthly income with the debt accumulating at the normal mortgage interest rate.

One possibility would be to allow the monthly payments to continue on a year to year assessment basis, in lieu of the 5 yearly review.

Reduced interest rate for less than maximum debt

An alternative approach would be to stop the monthly payments. Then apply a reduced reverse mortgage interest rate commensurate with the provider’s lower risk in the light of the debt being well below the maximum allowable reverse mortgage loan at that time.

Selling Process – Maximum Loan/Income

Currently, the assessment of the maximum lump sum reverse mortgage loan is set out in a table of percentages of the equity, depending on the age of the youngest applicant.

A suitable table could also be established for the maximum monthly income under the Home Income Plan on a similar basis – but noting that this is only guaranteed for 5 years.

Reassessment after 5/10 years

Under the Home Income Plan, the provider has the opportunity to review its position after a short period when only a part of the original maximum loan has been paid out. This should enable it to allow more generous conditions during this period than if it was “on the hook” for the original maximum. Also, both the provider and the retiree have the opportunity to take advantage of any “better than conservative” rise in the home values during this period when carrying out the reassessment.

The decision to extend the monthly income payment period will depend on the current equity, loan outstanding and ages of the retirees. Again a suitable table of maximum percentages of the current equity could be prepared for simple administrative purposes.

The table would need to be reviewed from time to time having regard to possible changes in experience assumptions.

Options for Retirees

At some stage during their retirement, the retirees (or the survivor if one has died) may wish to sell the home in order to move to a unit or to retirement accommodation.

In the latter case, the sale of the home, releasing the remaining equity after repayment of the outstanding debt, would maximise opportunities for desirable accommodation in a favoured location.

And the retirees would have received the benefit of a better lifestyle in their first (10) years of retirement.

Opportunities for Banks and other Providers

Reverse mortgages are currently not popular. Their appeal could be increased if a monthly income plan was introduced. This could satisfy the needs of many retirees.

It is to be hoped that this will be pursued.

CPD: Actuaries Institute Members can claim two CPD points for every hour of reading articles on Actuaries Digital.

Comments

Image of Peter
Peter says

June 17 2016

Some good ideas Geoff, The banks seem to charge a hefty risk premium when there is little risk at the early stages of the draw downs. Do you think they reserve these margins for when the risk exists, or release it to profit?

When I get around to needing this product, I would try to get a "standard interest only mortgage", say $400,000 and put it immediately into a 100% offset account. Repayments come for the offset account. No interest payable at day 1, draw down as needed and get mortgage interest rates only on amounts I need to use. When this $400,000 has been "maxed out" (about 6 years at 6% interest), then perhaps look for a Reverse Mortgage solution.


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