10 Mar, 2020
Plunging stock markets and minuscule bond yields are forcing increasingly desperate retirees to draw down on home equity in a scramble to boost income as retirement savings are squeezed ever harder.
Investors are panicking as they watch the S&P/ASX 200 index slump by almost 18 percent since hitting a record on February 20.
At the same time, safe haven buying is pushing investors towards the bond markets, with the yield on the 10-year government bond at a fresh record low of 0.57 percent.
Fears about the rapid spread of the coronavirus away from China are roiling financial markets, with a sharp slide in the oil price adding an extra layer of doom at the start of the week.
As companies face the prospect of frozen supply chains and reduced consumer demand from quarantined populations, dividend yield expectations are dwindling. Widely held banks are under special pressure from lower official cash rates, which eat directly into their net interest margins.
The Reserve Bank of Australia has stepped in to try and calm the turmoil, cutting the official cash rate by another 25 basis points last week. Interest rate markets are fully priced for another cut to the cash rate as soon as next month.
But falling interest rates penalise retirees who depend on income from cash at the bank or from term deposits. CBA, the nation's largest lender, has cut interest rates on some savings accounts by up to 30 basis points following last week's cut to cash rates.
Reverse mortgage push
Retirees are casting about for fresh ways to boost their income. Heartland Seniors Finance, an ASX-listed company that specialises in reverse mortgages, says demand for reverse mortgages has jumped by about 20 percent in 12 months.
A reverse mortgage lets borrowers from the age of 60 convert the equity in their homes into cash. The amount of equity that can be released is calculated by the borrower's age and value of the property.
A borrower can receive funds as a lump sum, a regular income stream, cash reserve or a combination of all three, and the mortgage, interest and fees do not need to be repaid until their home is sold.
Brendan Ryan, founder of Later Life Advice, which advises people on living off retirement savings, said reverse mortgages are attractive for asset-rich, cash-poor retirees seeking an alternative source of income.
“This is a very viable source of income for older Australians,” says Mr Ryan, who recommends that retirees consider setting up a scheme to tap into their capital when needed.
“The costs of setting them up is low and the comfort from having them in place – without having to draw down income – is very useful,” he says.
But terms and conditions vary widely between providers and many financial advisers are reluctant to recommend the schemes.
Paul Moran, principal of Moran Partners Financial Planning, said there are frequently no repayments made on a reverse mortgage and interest compounds, which means the borrower pays interest on the interest plus any fees or charges added to the loan.
“The amount borrowed can become substantial and significantly reduce expected inheritance, causing some estate beneficiaries to blame the adviser,” Mr Moran says.
Reverse mortgages are repaid when the house is sold, the last surviving borrower dies – if the mortgage is taken out as a couple – or the borrower moves into an aged care facility.
Improved regulation and rising property prices may allay retiree fears that they might lose their home or slip into negative equity, which means owing lenders more than the home is worth.
The government has strengthened regulation of the sector in a bid to improve consumer confidence and boost home equity as the third pillar of retirement income, after equity and fixed income. About 20,000 Australians are turning 65 every month.
The National Consumer Credit Act requires that a borrower must be shown – in person – how much the interest will amount to over the life of the loan and give the borrower a copy of the projections. The calculation must be made on an ASIC-approved website.
An average of 4.5 million retirees have equity in their homes that is about four to five times their super savings, which for male Baby Boomers is about $150,000 and for females around $80,000, according to government analysis.
Boomers in the nation’s largest cities are potentially sitting on giant nest eggs because the homes they bought 40 years ago have compounded in value to be among the world’s most expensive after Vancouver and Hong Kong.
“Retirees are worried about the low incomes their deposits generate. They are also worried that their falling super won't get them through retirement,” says Josh Funder, chief executive of Household Capital.
“Some savvy retirees also know that if you draw heavily on your super when it is down, it is hard for the super balance to recover with future growth,” adds Mr Funder.
“When superannuation is low and home equity is robust – that is the time when retirees are drawing on the third pillar of their retirement funding,” he says.
Reverse mortgages allow retirees to draw 15 percent of household equity at 60 and increase withdrawals by 1 percent a year for the next 20, or a cap of 35.5 percent.
Most lenders allow between 15 percent and 45 percent of a property’s value, with the amount increasing for older borrowers.
Borrowers need to consider the mix of interest rate, initial and break fees that best suit them. It is also important to contact the Department of Human Services on how any payments might affect pension benefits.
Aim for lower payments
Paul Dwyer, director of Reverse Mortgage Finance Solutions, advises borrowers to keep interest payments down by minimising the amount of equity that needs to be drawn down.
For example, interest rates vary from Household Capital’s 5.15 percent to Heartland Seniors Finance's 6.2 percent. Household Capital has an application fee of 1.5 percent on drawn capital with no ongoing fees while P&N Bank charges $395 and an ongoing annual fee of $80.
Household Capital modelling shows properties in Sydney's gentrifying Redfern are likely to provide better long-term retirement funding prospects than Melbourne’s Toorak, according to new assessments of the long-term value of property.
“It is not a home price index – there are other indexes predicting next year’s values,” Household Capital's Mr Funder says.
Based on Household's analysis, Forrest, which is five kilometres south of Canberra’s central business district, tops the nation as the best postcode for drawing down equity during retirement. Its long-term prospects are boosted by high incomes and stable federal employment.
The average superannuation balance of someone aged over 60 in Forrest is about $210,000 and more than 75 percent could on average tap home equity of about $322,000. The median price of a property is about $560,000.
Another top performer is Darling Point, about four kilometres east of Sydney’s CBD, where median house prices are about $5.6 million.
The average super balance of a Darling Point resident aged over 60 is about $415,000. More than 75 percent of the postcode’s homeowners could on average draw home equity of about $1 million.
Price volatility reduces long-term home equity prospects in many plush postcodes compared to their more stable but less expensive neighbours.
“Wealthy people in Toorak might have more home equity but volatile markets mean they might need to be more conservative about its management. Red Hill and Kew are more stable,” Mr Funder says.
The nation's top postcodes include: Forrest; Red Hill, about 84 kilometres south-east of Melbourne; Sydney's Darling Point, Eglinton, 44 kilometres north of Perth; and Bowral, 150 kilometres south-west of Sydney.