True cost of a reverse mortgage could be a lost inheritance

Asset-rich, cash-poor retirees are increasingly turning to the family home as a source of income. But there are risks, including for their kids.

Reverse mortgage are becoming more popular as retirees look to tap into their biggest wealth asset.

Asset-rich, cash-poor retirees are increasingly turning to the family home as a source of income. We’re not talking rent-a-room here, but the controversial reverse mortgage, which has staged a bit of a comeback.

More Australians pushing into retirement means demand for reverse mortgages is on the rise. It’s not hard to see why: Australia’s superannuation system may be the envy of the world but many retirees are still underfunded, with about 60 per cent leaving the workforce with less than $250,000 in super savings, according to consultancy Deloitte.

Retirees aren’t the only ones eyeing up the opportunity here: professional investors are also getting in on the action, with strong appetite among the investment community for mortgage-backed securities on offer from banks operating in this space.

Home equity access schemes, or reverse mortgages, allow retirees to borrow money using some of the equity in their home as security. They’ve been around a long time but remain a niche product – the major lenders do not operate in this market, with CBA the last of the big banks to axe a reverse mortgage offering back in 2018.

What’s on offer

Pensioners looking to go down this route typically have two options: a reverse mortgage with the likes of Household Capital or peer Heartland Bank, or the government home equity access scheme, which is more restrictive but offers much better rates. (These ultra-low rates, which have only come down as standard mortgage rates have risen, are a big driver of increased interest in retirees accessing their home equity.)

With a reverse mortgage from a bank, pensioners typically can access 20 to 25 per cent of the equity in their home, though this can push up to as high as 50 per cent, depending on the borrower’s age.

A 60-year-old homeowner may be able to borrow 20 per cent of the value of their home. As a guide you can then add 1 per cent for each year over 60. So, at 65, borrowers can access 25 per cent of their home equity, at age 70, that becomes 30 per cent.

There are a number of conditions, including that the house should be mortgage-free or, if there is a mortgage outstanding, that it is refinanced as part of the new reverse mortgage. No regular repayments are required – interest accrues over the life of the loan – so payment, of the initial loan amount plus the interest, can be deferred until the end of the loan, usually when the home is sold. With the debt growing over time, reverse mortgages can severely deplete wealth – and inheritances – though negative equity protections have been in place since 2012.

As these products become more popular, retirees’ motivation is also shifting. Cost-of-living requests such as debt consolidation and supplementing income are on the rise, while lifestyle requests, such as a new car or travel plans, have softened, according to Heartland Bank. Home improvements and debt consolidation remain the top two loan purposes.

A reverse mortgage from Heartland Bank comes with a variable rate of 9.75 per cent, while Household Capital’s sits at about 9.2 per cent with no regular repayments and 8.2 per cent where the customer chooses to make regular repayments.

Payment can be taken in a lump sum or instalments – keep in mind that lump sums may affect eligibility for the age pension.

Retirees also have the option of accessing the government’s own Home Equity Access Scheme (formerly Pension Loans Scheme), which offers a much better rate. In fact, the rate, at 3.95 per cent, is by far the best in the market and compares with standard mortgage rates above 6 per cent.

The heavily discounted rate has, unsurprisingly, proven popular: The number of retirees using the Home Equity Access Scheme jumped 40 per cent over the 12 months to the end of June, to a reported 13,749. This compares with 700 who took up the scheme in 2019.

Interest rates

With the 3.95 per cent rate being lower than what it costs the government to borrow, industry players are beginning to ask whether it should be reviewed.

“The home equity access scheme is fantastic – it’s a positive intervention in the market,” says Household Capital’s Joshua Funder, who is supportive of the government scheme but says the current rate is too low.

“I would much prefer the scheme was sustainably indexed so the government could grow that and meet the needs of the population. We already have compounding products such as HECS and I think we should be fair to students and retirees by being market-neutral, sustainably priced and regulated,” he says.

The government scheme is growing at three times system and is distorting the market, he adds.

“It’s a very heavy subsidy from the government and it doesn’t factor in risk, cost to originate or cost to service.”

Leaving aside the rate, which is undeniably good for retirees, the scheme is more restrictive than reverse mortgages offered by commercial lenders. The maximum payment is 150 per cent of the aged pension rate. For those receiving the full aged pension, they can top up 50 per cent under the government scheme, while those with no aged pension can get the full 150 per cent of the aged pension loan amount.

Even in this competitive landscape, lenders are growing their loan book: Heartland saw about 18 per cent growth in the 2023 financial year (2024 numbers aren’t out yet) and Household Capital has built a mortgage portfolio of more than $450m in five years.

Like retirees, investors realise the popularity of these products. Household Capital has just priced its first residential mortgage-backed securitisation (RMBS) issuance, raising $263m from local and global investors.