Thousands of Australian retirees have taken out a reverse mortgage on their home – but is it the best option for your older clients?
POPI general manager, Brenton Harris, doesn’t think so. He believes many reverse mortgage holders start off with the best of intentions, only to find themselves in financial ruin later on down the track.
“The worst problem with reverse mortgages is the misuse of funds. Everyone starts out with all the best intentions of only drawing out a little bit and they end up drawing the thing down to its limit within, what we’re seeing, a couple of years. And then they’re on the slippery slope, really, because the capitalising interest starts to get away from them.”
Harris says he’s even come across one older client who had a drawer filled with unopened monthly envelopes from the bank, because she couldn’t bear to see the interest going on top of the loan each month.
“From what we’ve seen, people get very stressed about them,” he adds. “The government has legislated no negative equity guarantee and that kind of says something, in my opinion, that even the government thinks that retirees are at extreme risk of ending up with nothing in their home, hence they have to legislate it.”
But Darren Moffatt, creator of mortgage sties housenet.com.au and reversemortgagewatch.com.au, says the idea that the majority of reverse mortgage holders end up financially ruined is ‘completely incorrect’.
“I can tell you I’ve done a very, very large number of these transactions over the years and the vast majority of people choose to boost their pension and they use most of the money gradually over time. Obviously, there are a small minority who take out lump sums or spend the money to repay existing debt.”
Moffatt says a ‘typical’ reverse mort lender will use a small sum to buy a car or do urgent repairs.
“By doing it this way, the cost is extremely modest, but it also doesn’t have any implications for their pension - which can be the difference between this and other equity release schemes.”
However, Moffatt acknowledges the validity of reversion schemes or equity products, like POPI.
“Generally, as a rule, these…have a place in the market – I’m not disputing that. My experience is that those schemes are better where someone has a need for a larger lump sum, like to extinguish an existing mortgage debt. For those types of clients, home reversion or pure equity work well. But my experience is the vast majority of seniors want their money gradually over time. So, on that basis, the reverse mortgage is a good option.”
But Harris believes these situations are actually few and far between.
“[Reverse mortgages work] where someone has only taken a very small percentage, usually of a property that is in a very high-growth area and is of reasonably significant value. So someone may have a $700k property and they’ve taken a $50k reverse mortgage to do some repairs on the property – which in fact helps its value – that’s generally where you can say, ‘well, the reverse mortgage, yes, it’s going to increase in value, but as a percentage of the overall property value, it’s not too bad’.”
The key differences between a POPI and a reverse mortgage, he says, is that there’s no loan with a POPI, so there’s no risk of capitalising interest ‘eating away at equity’.
“What we see are banks offering these wonderfully-pictured graphs where they’ve got two smooth lines, one with the property value going up, one with the reverse mortgage going up and most of the time they pitch it so they say ‘look – your equity is the same after 20 years. Although the loan’s a lot higher, so is your property and look, you’ve still got the equity you started with’. With a POPI, that’s always the case because you’re not eating into it, you’re not selling part of your house. You’re only really selling in the future.”
“The other key difference is a POPI is a transfer of risk. With a reverse mortgage, the property owner takes on the risk of what the property market’s performance is going to do, whereas with a POPI, they’re transferring that risk to an investor. They’re still benefiting from it from a cash-flow perspective, but not taking on the risk that property markets fall or property markets stay flat, that they’re losing and eroding away on equity.”
Both Harris and Moffatt can agree that the final decision comes down to the individual client, but what should be done with the majority of clients remains up for discussion.
“It all depends on the client…under NCCP, we have to make individual assessments,” notes Moffatt. “There is a fairly typical reverses mortgage profile and that’s someone who owns a property of roughly average value for their area and has very little other assets or superannuations - your typical retired person in Australia. Those people are using a small lump sum – like less than $30-40k, but then they want additional moneys available to supplement their pension over ten to twenty years. That’s where the reverse mort product works very, very well.”
However, Harris remains convinced that reverse mortgages are only successful in a minority of cases and must be investigated with caution.
“I’m a financial planner and mortgage broker by profession and I have done reverse mortgages in the past as a broker, which kind of led myself and my business partner Sean to create POPI. We’re in the business of building a happy client base and I think a reverse mortgage is actually the opposite. You’re actually building a client base that’s going to end up very unhappy and, for me, that’s just not good business.”