As some people approach retirement, they may find they are asset-rich but cash-poor. If they own their own home, the options of downsizing or taking out a reverse mortgage can offer solutions to the cash flow problem – but which is best?
Whatever their pros and cons, both solutions might be more in demand in the future, with the Australian Housing and Urban Research Institute (AHURi) recently reporting on mortgage stress on older Australians. The report notes that mortgage debt for people over 55 has increased from an average of $27,000 in 1987 to over $185,000 in 2015. This rise of over 600% naturally has an impact on older Australians still repaying mortgage debt and those having equity tied up in the family home when income and cash flow may be more restricted.
A common way of realising cash flow from the home is to downsize – to sell the large family home and buy something smaller and less expensive. It’s an easy-to-understand strategy and can give retirees a good amount of cash on hand for their retirement.
There are downsides to downsizing, however. The sale of one property to purchase another is subject to agents’ fees and stamp duty, which combined may cost from $20,000 to $40,000.
Cash in the bank may also affect your government pension, because while the family home isn’t included in the assessment, your cash assets are. Trading the equity in your home for a lump sum of accessible cash could reduce your income and be less positive than you expected.
Another option is the reverse mortgage. Many people are wary of the idea and know little about it. Moneysmart describes a reverse mortgage as “a type of loan that allows you to borrow money using the equity in your home as security. The loan can be taken as a lump sum, a regular income stream, a line of credit or a combination of these options.” These loans are usually around 1% higher than a regular home loan.
Interest is charged on the sum borrowed, but neither the capital nor the interest has to be paid while you live in your home. However, once you leave – either when you pass away or move into aged care – the house is sold to repay the debt. The residue of the funds goes to you or your estate.
Government consumer and credit reforms protect the borrower against negative equity – which means, you can’t end up owing more than the property is worth by borrowing beyond your means. This also introduces restrictions on the ratio of the asset’s value you can borrow.
While you can generally borrow up to 80% of the value towards buying a property, reverse mortgages can be more risky for the lender, depending on the age, condition and value growth potential of the house, and the age, life expectancy and debt level of the person borrowing against their equity. The younger you are (and the longer the lender has to wait to be able to settle the debt) the less you can borrow.
Generally, banks won’t lend more than 60% of the property’s value, and once you’ve spent up to the agreed limit, the house has to be sold to pay the debt. That means the timing of when you take up the debt and how quickly you use the cash versus your expected lifespan or when you expect to go into aged care are important factors to consider.
If you are starting to think about how to fund your retirement, a financial plan is the first step. If you would like to speak with a professional investment adviser about downsizing versus reverse mortgages or other retirement funding strategies, contact United Global Capital today on 03 8657 7640 or email [email protected] for a no cost, no obligation consultation.