The Treasurer’s budget decision to extend the Pension Loans Scheme to cover all homeowners of age pension age for annual drawdowns of up to 150 per cent of the full age pension entitlement is welcome news. Not only does it provide an official seal of approval for using a reverse mortgage to access equity in the family home but it also allows more people to borrow money from the federal government.
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The 5.25 per cent annual compound interest rate is below the interest rates charged by private sector reverse mortgage suppliers. Also, there are sound reasons for retirees to be confident they won’t be ripped off if they opt to make use of the equity in their home to top up their living standard by a regular fortnightly drawdown.
As with any reverse mortgage, there are limits to the amount that can be borrowed and legal and other administrative set-up fees. But particularly at older ages, especially for people without family financial support, using a reverse mortgage can delay the need to sell the family home by helping to maintain living standards.
The outstanding loan balance does increase every year because of drawdowns plus compound interest. The interest costs will largely be matched by increases in the tax-free capital gains from continuing to own the property. The costs of continuing to live in the family home will often be less than the costs of alternative accommodation.
When there’s substantial equity in the family home, selling the property increases the risks of losing part or all of any age pension entitlement. The problem when there are sizeable proceeds from selling the family home is that when it applies, the assets test reduces age pension entitlement by 7.8 per cent of the assessed assets. Very few retirees can earn investment returns as high as this which makes the 5.25 per cent reverse mortgage interest rate attractive.
Using the Pension Loans Scheme or another reverse mortgage to retain maximum possible access to the age pension expands the options available to retirees. For example, delaying the sale of the house can reduce the amount of assets subject to the assets test at the time of sale.
Having government as the owner of the reverse mortgage provides certainty that the mortgage won’t be called upon until when the house is sold. There’s also a tidy profit for the government in that the 5.25 per cent interest rate is higher than its current 10-year bond costs of less than 3 per cent.
Retirees wanting access to lump sum drawdowns on their home equity will still have to deal with the private sector. The Pension Loans Scheme provides a regular fortnightly stream of income.
Daryl Dixon is the executive chairman of Dixon Advisory. comments@dixon.com.au
