How useful are home equity release products for asset rich but income poor retirees?

Could home equity release products become the new credit card for retirees looking to make ends meet?

New research commissioned by Te Ara Ahunga Ora Retirement Commission suggests 25% of older households who have high levels of equity in their home – but low retirement savings and income – could benefit more from equity release products than loans or credit cards.

Economic research institute Motu Research was hired by the Commission to see if home equity release schemes could provide value for money, plus how they might provide a suitable form of retirement income for some older people.(See Motu's report here).

The Commission said home equity represents a key source of wealth for many New Zealanders over the age of 65, and home equity release products could be a better alternative for older New Zealanders who are struggling financially instead of taking on higher-cost consumer debt.

The Commission said people in this “asset rich income poor” position tend to be 75 or older, non-Māori, and no longer in paid employment, and on average these households have home equity of just over $600,000, which can potentially be released to supplement retirement income.

What are reverse mortgages and what's home reversion?

The two main home equity products available are reverse mortgages and home reversion. 

A reverse mortgage is a loan that allows homeowners aged 60 or older to borrow against the value of their home. Unlike a traditional loan, a reverse mortgage doesn't require any repayments to be made. Instead, the loan is repaid from the sale proceeds of the home when the homeowner decides to move out or passes away. Any equity remaining after paying back the loan is returned to the homeowner. There is no set term for the loan, meaning the homeowner can live in their home for as long as they wish. Reverse mortgage interest rates are higher than those on standard floating mortgages.

"A major risk with a reverse mortgage is the possibility that it will completely erode the equity in the home. The combination of compounding interest and zero repayments means that borrowers who keep their reverse mortgage for a relatively long period of time risk losing all equity in their home," the Motu report says.

A home reversion plan involves the homeowner selling a portion of their home in exchange for a lump sum of cash or stream of income payments. When the home is sold, the home reversion provider will receive a share of the sale proceeds and the homeowner or their estate will receive the rest. Although the homeowner no longer fully owns the home, they are allowed to live in it for as long as they wish. Furthermore, a home reversion plan does not involve any debt.

Motu notes because Lifetime Retirement Income only released its Lifetime Home product, essentially a home reversion plan, this year and it's the first of its kind, "little is known about its benefits and risks to retiree homeowners in New Zealand."

The Commission said reverse mortgages were more suitable for people who don’t need to preserve the equity in their home for future use. 

The Commission noted that reverse mortgages also cost less in low interest rate environments and when house price growth is high, that can partially offset the impact of interest rates on the erosion of equity.

“People opting for a reverse mortgage should consider only using the minimum they need to supplement their monthly income rather than larger lump sum withdrawals, as this will slow the rate at which the interest owing builds up over time,” Commission Policy Lead Michelle Reyers said.

However, if people go down the home reversion route, it avoids interest compounding and provides certainty to the homeowner that they’ll hold onto a specific percentage of equity in their home.

The Commission also pointed out that the purchasing power of the income received decreases over time from home reversion due to inflation as the income received per year is fixed.

Not well understood

Due to the complexity and costs involved, the Commission said home equity release products “are not well understood” in NZ.

“For the group of retirees relying primarily on New Zealand Super for income who have home equity but no other assets (such as KiwiSaver) to draw down, it is something to consider,” Reyers said.

The “key” to using home equity release products was understanding the costs and benefits as well as seeking financial advice to see if they were the right fit.

People need to think about their retirement in “stages”, she said, like what other assets they could rely on in retirement – KiwiSaver for example – or if working past the age of 65 was an option.

“Balancing whether you can afford to use some equity now but maintain the required level of equity in your home for another stage of retirement should your health or life circumstances change may require professional advice,” the Commission said.