The most common type of wealth-holding by older people in New Zealand is home ownership. A mortgage-free home represents a lifetime of accumulated savings. If we had saved $400,000 through our lifetime why wouldn’t we use the money to make our retirement years more enjoyable and comfortable?
How can this asset be used in the lifetime of the owners?
First of all, we must decide whether to preserve funds tied up in housing or use them in some way. Most people do nothing and their equity is preserved for inheritance after they die.
Home equity can be used, as security for a loan, when a special need arises, such as medical emergencies or a family crisis. This is the ‘saving it for a rainy day’ approach.
Releasing housing wealth
If the choice is to “mobilise’, the first decision is whether to remain in our home. If it is sold, part of the capital may be released by ‘trading down’ to cheaper housing, perhaps an apartment or town house or a retirement village. Many people successfully trade down in, or approaching, retirement.
If we sell, all the equity is released to spend or reinvest. But then we must find somewhere else to live, incurring the costs of renting or boarding. We will have to balance returns from investing the house sale proceeds against the costs of alternative accommodation and the implications of losing homeownership.
Several other options will allow us to remain in our familiar home and community. We could share – taking in boarders or flatmates. Large family homes may be converted into flats, if we are prepared for the responsibility and problems of being a landlord. Where a section is big enough, subdivision may be possible, with surplus land to sell or build on for rent.
But then we could stay in our homes and borrow against the equity. A new mortgage may not be attractive as this means repaying capital and/or interest. But there are now commercial “equity release” schemes as further options for older people who are “housing rich but income poor”.
There are several types of equity release schemes, but in New Zealand these are, and have mostly been, reverse mortgages. Here, a loan is taken out against capital tied up in a house. No immediate repayments of capital or interest are required. Interest accumulates on a compound basis and is added to the loan. Most schemes offer a “no negative equity guarantee”, which ensures that the debt will never exceed the value of the property, even with added interest. Some types of scheme have fixed terms, but usually, when the client dies or the property is sold, the full loan plus interest is repayable.
Reverse mortgage schemes can provide lump sums, regular income, line-of–credit arrangements, or combinations of these. The line-of-credit option allows people to draw amounts of cash as and when needed. This reduces the amount of interest which is “rolled up.”
Pros and cons
Reverse mortgages are often seen as a “last resort”; the interest rates are high and compound fiercely and they limit choices about moving in later life. They also reduce funds for inheritance. Critics advise against using the schemes too soon, especially for everyday expenses, and to avoid schemes that involve high-interest investments or risky property developments.
But it seems there is potential for safe, well-designed and innovative equity release products to play a larger part in helping older people to release capital when they want to stay put. Flexibility in the use of housing wealth can provide older people with financial security/freedom, improved quality of life and peace of mind. A lot depends on how acceptable this idea is to them.
By Judith Davey, Senior Associate, Institute for Governance and Policy Studies, Victoria University