The key to a comfortable, secure retirement is to have a debt-free home and a pot of money invested to cover the important and enjoyable things in life. Research published a couple of years ago by Massey University’s FinEd Centre shows clearly that NZ Superannuation is not enough to get by on. The report estimated that a lump sum of between $21,000 and $783,000 is required to fund the gap, depending on where you live (city dwellers need more) and how frugal you are. These figures are probably an understatement now. Yet statistics also show that around 40% of retirees have their home and not a lot else. While they might be asset rich, they are cash poor.
For the majority of New Zealanders their home is their most valuable asset, far exceeding the value of their retirement savings. A home is full of memories, and connects people to family, friends and their local community. The challenge for many retirees is how to access the wealth that is tied up in their home without being forced to sell it.
One of the ways to do this is to take out a reverse mortgage, currently available from Heartland Bank, SBS Bank and First Mortgage Trust. The key difference between a regular mortgage and a reverse mortgage is that the borrower is not required to pay either interest or principal until such time as the property is sold. It is available to people over the age of 60 and it usually stays in place until such time as the borrower moves into a retirement village or rest home or passes away. Interest is added to the loan monthly over the life of the loan – in other words, it compounds. It is this particular feature which creates the most consternation amongst potential borrowers.
For a generation who grew up believing that debt is something to be either avoided at all costs or repaid as quickly as possible, the idea of borrowing with compound interest sounds like a bad financial decision. But is it really?
The amount you can borrow is dependent on the age of the youngest borrower as well as the value of your home. This is to ensure that the amount of compound interest has a good chance of being at least partially offset by the increase in your property value over time. The way the maths works is that while you are clocking up interest on a loan amount which is only a fraction of the value of your home, you continue to get the benefit of the percentage increase in the total value of the home.
For example, let’s say at age 70 you borrow $200,000 on a home that is worth $1,000,000. Assuming an interest rate of 5.95% and a 3% growth in property prices, the loan amount after 10 years with compound interest added will be around $356,000. However, the value of the property will be around $1,343,000, leaving around $987,000 if the property is sold at that point and the debt repaid. With a 5% growth in property prices over the 10 years, the remaining equity will be even higher.
The funds you obtain from a reverse mortgage can be spent on whatever you like. This includes providing a regular top-up to your income, paying for essential costs such as home maintenance and health care and paying for the things that make life enjoyable such as travel or a new car. The mortgage comes with a guarantee that the amount you owe will never exceed the value of the property. You have guaranteed occupancy of your home for your lifetime or until you sell.
The golden rules of taking out a reverse mortgage are:
- Use your savings first before you borrow, while still leaving yourself a small cash buffer.
- Explore other options first, such as downsizing your home or getting help from your children
- Only borrow what you need. Borrow for essential things like maintaining your home, replacing your car or paying for health costs.
- Only borrow when you need it. Wait as long as you can before borrowing and at the time when you need to pay for something.
The flexibility of a reverse mortgage helps in this regard. You can obtain approval for a borrowing limit and withdraw funds as required after borrowing an initial small amount. You can also arrange a monthly payment rather than borrowing a lump sum. Once you have borrowed what you want, it’s a good idea to make repayments if you can whenever you have surplus funds, so as to keep the interest costs down.
The one big catch with reverse mortgages is what might happen if you sell your house before you die. You can take a reverse mortgage with you providing you still meet the lending criteria with the new house, particularly in terms of percentage value of the borrowing in relation to the value of the house. If you plan to move to a retirement village, be aware that most villages will not allow a reverse mortgage and you have to buy within the net amount you receive when you sell your home.
You should also be aware that the interest rate can vary over time and that property prices don’t always increase.
At the end of the day, the cost of a reverse mortgage is borne not by you but by the beneficiaries of your estate. Given a choice between having an enjoyable, comfortable retirement and preserving money for the next generation, I know what I would do!