Reverse mortgages, or equity release loans; Socially responsible finance for senior citizens, or risky for borrowers and their bank lenders?

By Gareth Vaughan

They often get a bad rap in the media, almost ceased in New Zealand when the global financial crisis hit, and feature compounding interest meaning the overall cost of the loan grows significantly over time.

But this hasn't stopped Heartland Bank plunging into the reverse mortgage, or equity release loan, market following last year's acquisition of Sentinel and the Australian Seniors Finance business. Andrew Ford, Heartland Bank's national retail manager, is - not surprisingly - something of a champion for reverse equity mortgages.

"What they enable our customers to do can be quite transformational," Ford told interest.co.nz in a Double Shot interview. "It (a reverse mortgage) can truly change lives."

Designed specifically for senior citizens, a reverse mortgage has no regular repayments. They enable people who own their own home outright, or have a small existing mortgage, to access some of the equity or cash tied up in their home to use for any purpose they choose. 

"That can be to renovate the property, to upgrade a motor vehicle, to travel is a really common one, or just to take some of that stress out of day to day bills. When you're on superannuation it's often enough to cover the bare essentials but doesn't stretch to the one-off expenses or increasing costs such as rates and insurance," said Ford.

As Ford puts it borrowers can "do the things that they want to do in retirement and enjoy that financial freedom and independence of being able to stay in their own home."

Why floating mortgage rates, and why so much higher than for standard home loans?

The loan is repaid when customers leave their home. During the term of the loan interest compounds monthly. Aside from Heartland, ASB and SBS Bank also offer reverse mortgages.

The floating, or variable, interest rates on the loans are significantly higher than interest rates on standard floating mortgages. Heartland's, for example is 8.35%, versus carded floating rate mortgages on standard home loans at other banks of around 6.65% to 6.75%.

"In terms of the fact that it's a variable interest rate we think with this demographic, which is retirees and seniors, that it's much more important to have the flexibility of a floating rate than the certainty of a fixed rate. There are no repayments on this loan so it doesn't impact the customer at all from a cashflow perspective. But with our product it gives them the complete flexibility to repay it at any time if they choose to. So we think that flexibility's more important than certainty," said Ford.

In terms of the premium over standard home loan variable rates, Ford suggested there were a few reasons for that.

"First of all there's no repayments so from our perspective we get no cashflow from the loan. We've also got a number of things built into the product to make sure that it is really socially responsible and that includes we guarantee the fact that the customer can never owe us more than the house is worth, so we take that risk," said Ford. 

"We also guarantee lifetime occupancy. With a reverse mortgage there is no term so we guarantee the customer can stay there for as long as they like and that they never have to make us a payment. So because of those guarantees it effectively means that we take more risk than a standard variable rate, a standard residential mortgage, where there's typically people earning income and different ways of repaying. So hence why there's a premium at 1.5% to 2% above variable rates."

How much equity someone can release from their home is based on their property value and age. Ford said the average age of Heartland's reverse mortgage customers is 72 to 73, their median loan term is eight to nine years, and the average amount released, or borrowed, last year was $45,000. 

What happens if house prices fall?

An obvious question for someone considering taking on a reverse mortgage is what happens if the value of their house declines?

"First of all we protect the customer. We guarantee that they will never owe us more than the house is worth. So they're protected from that and they can also take out our equity protection option and protect a portion of their equity," said Ford.

"But if house prices fall it's the same as if you own your house with no mortgage or with a standard residential mortgage, your equity will diminish based on what house price moves do. So we make sure that during our fulfillment process that customers aren't assuming current Auckland prices continue on for ever and neither do we in terms of our modelling."

In terms of what constitutes a default on a reverse mortgage, Ford said because there are no regular payments, customers can't default on payments.

"In terms of default really it would have to be something similar to any other contract around if there was any fraud involved. In terms of a property if there was something that was done to it that could materially diminish  the value, if they were to make structural changes that could diminish the value without consents and so forth. So we have that type of protection in there for us so that the asset's going to maintain its value," Ford said.

"You can takeout a reverse mortgage if you've got another mortgage, but the reverse mortgage must be used to repay the other mortgage. We're getting that more and more."

Risks for lenders too

The Reserve Bank estimates there are about $400 million to $500 million worth of reverse mortgage assets held by New Zealand banks, which is a tiny fraction of the about $200 billion worth of home loans outstanding. Nonetheless in March the Reserve Bank revealed plans to introduce specific bank capital rules for reverse mortgages, which could increase the amount of capital banks have to hold against such loans potentially making them more expensive for borrowers. Currently there are no explicit capital requirements for reverse mortgages. The Reserve Bank's plans, have, however, been put on ice for the time being.

The Reserve Bank says with growing numbers of people reaching retirement age in coming years and decades, there's potential for reverse mortgage lending to increase. In some of its promotional material Heartland says almost 75% of people aged over 65 own their own home, with more than 90% - or nearly 300,000 - owning their home without a mortgage. Against this backdrop the median income for a New Zealand retiree is $20,000, Heartland says.

The Reserve Bank, meanwhile, sees potential risks for the lenders.

"One key risk to the lender stems from the borrower staying in the property longer than anticipated. Another risk arises from a fall in the value of the property. Both of those happening at the same time would pose the greatest risk for the lender," the Reserve Bank says.

The Banking Ombudsman's office has had just one enquiry about reverse equity mortgages during the past couple of years. Banking Ombudsman Deborah Battell said reverse mortgages can be a really good way to access capital, but it gets used up really quickly and comes with compounding interest rates. Battell recommends anyone considering taking out such a loan makes an informed decision.

The Ministry of Social Development has a voluntary home equity release Code of Standards.

'Approach with great caution'

In a December 2007 paper on reverse mortgages, the Auckland District Law Society said "by their very nature, reverse mortgages are a product that should be approached with great caution and effort at understanding."

"It seems inevitable with an ageing population that these products are around to stay. They are undoubtedly a commercial response to a situation brought about by the combination of that ageing population and the Kiwi love of owning our own homes, above all else. Reverse mortgages should be entertained only by those who have carefully explored and eliminated their other options, investigated the specific product under consideration and taken independent legal advice - and, perhaps, who are over 70 and not looking to borrow more than a small proportion of the value of their home," the Auckland District Law Society concluded.

Asked about these comments Ford said in principle he agreed.

"(But) that is 2007 and so it's quite dated. There were a number of poorly developed and poorly sold reverse mortgage type products out there (then)," said Ford.

"When Heartland entered this market, being a registered bank, we were very careful that we made sure that our product was socially responsible and that we could stand behind it from a reputation perspective."

"In terms of what the Law Society's saying there, overall I agree and a lot of it's hard coded into our process. We make sure customers get legal advice and it's independent. They should consider all options. Our application process takes them through different options. It'd probably be the only financial product that I'm aware of that actually says have you considered for instance downsizing, (and) have you considered borrowing from friends and family. Have you discussed it with your family. and if not why not," Ford said.

The Heartland table below shows the maximum percentage of a home’s value people can borrow from Heartland at various ages. The percentage is based on the age of the youngest borrower minus 45, with the ages below shown as examples. Heartland also has a calculator here.

And here's ASB equivalent table.

And below's an example from ASB of a reverse mortgage.

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