Why Choice is wrong on Reverse Mortgage
01 July 2016
In February this year the consumer group Choice published an article on home equity release finance options for seniors. Although generally I’m a fan of their work, on this occasion the article was regrettably full of factual errors and hyperbole.
Early in the piece the author states that “It can be a viable option, but only if you need to borrow a lump sum for a necessary renovation, a critical medical treatment, or a similar one-off expense.”
I find it surprising that a pro-consumer group would urge seniors to use these products only on a lump sum basis. Anyone with a basic knowledge of how compound interest works will understand that it is always cheaper to draw funds gradually over time, rather than as a lump sum upfront. Indeed, significant interest savings only become evident when funds are drawn in this manner. It’s one of the main reasons why we developed our monthly regular advance option.
He then goes on to advocate that:
“Borrowing against your home to help balance your personal budget or fund a round-the-world trip is not a good idea – a point not generally emphasised by the businesses that market equity release products. You'll potentially be giving away the farm in return for a quick financial fix”
I have to wonder whether he’s ever tried living on the aged pension? Many of our customers know how hard it is to make ends meet on the pension. Accessing some of the home equity is not a luxury, but often a necessity just to get bills paid and enjoy a modest retirement lifestyle. After years of hard work, if you wish to enjoy retirement with some travel, this dream should be allowed to be realised. Reverse Mortgages can be a much cheaper option than other common cash flow alternatives, such as credit cards or personal loans.
The author then states:
“For cash-poor Australian homeowners, the marketing of home equity products can be hard to resist, but it probably makes more sense to cut costs and downsize rather than put your biggest asset on the line.”
We agree that downsizing can be an excellent option. If you are lucky enough to possess sufficient excess value in the current home to allow a sale, and re-purchase at a lower price point within your desired location then this is a great way to go. In these circumstances there may well be no need for home equity release finance.
However in reality, most seniors own homes worth around the median value for properties in their local area. After allowing for agent fees, stamp duty, and transfer costs, it can be uneconomic to ‘downsize’ in the local market they call home. And sure while it may be possible to downsize to a cheaper suburb, many seniors are understandably reluctant to move to an unknown suburb or city, away from friends, family, and their support network.
Insisting that seniors simply ‘cut costs’ and ‘downsize’ regardless of these considerations seems a pretty grim prognosis for retirement. What’s more, downsizing limits upside from increasing house prices.
When the article addresses Reverse Mortgages directly, the use of emotional language and hyperbole is both inaccurate and unhelpful to Australian seniors considering such an option:
“It's a potential ticking time bomb because you don't have to make any repayments until one of these events occurs – so the final payback amount can be huge depending on how much you borrowed.”
Firstly, the author fails to mention that borrowers are welcome to make repayments whenever they wish; the loan can be paid down over time by the borrower or by their family. Secondly, he makes no mention of the fact that most borrowers do in fact draw funds gradually over time, thereby enjoying substantially lower interest costs.
Thirdly, in relation to the ‘ticking time bomb’ claim while he does concede Reverse Mortgages are heavily regulated by government with substantial consumer protections, both mandated by law, the reality is that the vast majority of all Reverse Mortgage contracts transacted within Australia over the last decade contain a ‘No Negative Equity guarantee’ . On any reasonable measure, there is no ‘ticking time bomb’.
Finally, the example used by the author of a 10% interest rate for the entire term of the loan bears no resemblance to the real life experience of most Reverse Mortgage borrowers. At the time of writing, our rate is 6.29% and the RBA cash rate is 1.75%, with most pundits tipping further falls to come. The possibility of a 10% interest rate for the life of the loan is so remote as to provide an entirely irrelevant illustration that adds little value to senior consumers.
There’s no doubt that groups such as Choice have an important role to play in educating and informing consumers, and that industry benefits from the scrutiny of a critical independent voice. However, all market participants are better served if analysis is accurate and conducted without recourse to sensationalism.
Disclaimer: The information in this article does not constitute financial advice. This article is only intended to generate a discussion.