Two weeks ago we discussed the Lifetime home retirement income product. A new product to the market for those aged 70 and older that need or want to use equity in their home and turn it into income.

In that article I teased that I would compare this product to its main competition. The reverse mortgage. Well today is not that day! Maybe next week 😊

First I wanted to provide an overview of reverse mortgages, as I haven’t thoroughly been over these before, and the outcome of taking one out.

What is a reverse mortgage?

The only real similarity with the Lifetime home product is that it provides an income. But with a reverse mortgage you don’t sell part of your house to an outside party. You borrow against the property in the form of a loan from the bank.

The current banks that offer a reverse mortgage are Heartland Bank and SBS bank.

Typically they allow you to borrow up to 30% of the value the property, predominantly dependent on your age and location. The youngest borrower can typically borrow:

Age 60 – 20% (10% with SBS bank)
Age 65 – 25% (15% with SBS Bank)
Age 70 – 30% (20% with SBS bank)
Age 75 – 35% (25% with SBS Bank)
Age 80 – 40% (30% with SBS Bank)
Age 85 – 45% (35% with SBS Bank)

The amount can vary based on personal circumstances so these numbers are a general guide only.

With a normal table mortgage, interest payments are highest at the beginning of the loan when the loan is the largest. With a reverse mortgage, interest payments balloon the longer you hold the loan. Funnily enough, the reverse of a normal mortgage. Go figure.

The danger with reverse mortgages being that they are interest only loans. You don’t pay down any principal (unless you can and want to, although I don’t know why you would take out a reverse mortgage only to pay it off). This means that the loans balloon out to a significant number if you take out the loan for too long. You don’t pay off the loan until you sell the home, move into long term care, or pass away.

Reverse mortgages also use a variable interest rate which can go up or down. The variable rate is typically a couple of percentage points more than the current floating mortgage rate too. For example, most banks are currently charging a floating rate of around 8.5% (June 2024). The reverse mortgage providers are currently charging around 10.5% on their reverse mortgage offerings.

Reverse mortgages also carry quite a few fees that will be covered soon.

Because of the non payment of the loan, the high interest rate, and time, the loan can get to eye watering levels. We will show this with an example later.

You can borrow the money as a lump sum up front payment, or as a monthly payment. How you withdraw it is based on your needs. For example, if you have a one off expense you can’t cover such as home repairs or travel, then a lump sum works best. If you have ongoing spending needs, such as a top up for your spending, then a monthly payment will work best. The less money you hold for the longest time as possible is best.

Both providers of reverse mortgages in New Zealand guarantee that if you get to a situation where the size of the loan outsizes the value of the property, that you will not be on the hook for the difference.

General conditions of a reverse mortgage

You will need to be minimum age 60. If you are in a partnership, the youngest person in the couple must be at least age 60.
Your home will need to be mortgage free or very close to.
Your home should be in good condition and this condition maintained as best as possible.
Your home must be of residential type.
Your home must be of a value, size and location that is approved by the lending bank.
Your home must be insured.
You will need to get a valuation for the property so the banks know how much they can lend you.
You may need permission from the bank to make any significant changes to the property.
There are often minimums of how much you can withdraw using either the lump sum or ongoing monthly payment option. Typically around $5,000 for the lump sum and $300 for the monthly option.

Typical fees for a reverse mortgage

Of course there is the ongoing mortgage interest rate being added to the loan.
Legal fees to look over the contract.
House insurance, if you don’t have already.
A valuation fee to have the property valued.
Loan set up fee
Fees for each amount withdrawn
Fee for discharging the loan

Each provider charges for these loans in different ways (and are often updated), so that is why I haven’t put figures down here as the amounts and type of fee can vary. You can have a look at the two main provider fees here and here.

Looking at the current offerings though, it appears SBS charge much less in fees. Do note though, that SBS are less aggressive with how much they let you borrow. For example, at age 65 Heartland can lend up to 25% of the house value, but SBS just 15%. Not necessarily a bad thing!

To show the impact of fees on a reverse mortgage we will take a look at the difference between a few borrowing amounts:

Loan balance on a $50,000 reverse mortgage over various time periods with a 10% interest rate

Loan balance on a $100,000 reverse mortgage over various time periods with a 10% interest rate

Loan balance on a $150,000 reverse mortgage over various time periods with a 10% interest rate

Loan balance on a $200,000 reverse mortgage over various time periods with a 10% interest rate

Loan balance on a $300,000 reverse mortgage over various time periods with a 10% interest rate

The loan amount almost doubling over 5 year periods, almost tripling over 10 year periods, 7.5 times over 20 year periods, and growing over 19 times in 30 years!

We will find out soon how much our house needs to increase in price to keep up with the increase in size of the loan.

Pros and cons of a reverse mortgage

Pros:

Good if you don’t have enough savings to fund your lifestyle. Provides some income for you.
If property prices increase by a lot, you get to receive income and not lose value in the house.
You don’t have to give up the equity in your home.

Cons:

Very expensive due to high interest rates, plethora of fees, structure of the loan where you don’t pay principal, and possible length of loan.
The loan is on a floating rate which can increase at any time.
If house prices don’t increase by a lot, depending how long you take the loan out for, you could end up with a loan that is almost (or more) than the value of the house.
This then makes it difficult if your situation changes and you need to move house for example. You will have no equity to pay for your new accommodation.
Or it could potentially leave little for your family with regards to a legacy.
You lose some autonomy. You can’t do anything you want to the house, like make changes or rent it out. You will need to seek approval from the bank.

An analysis of a reverse mortgage

Just like we did with the Lifetime home income product last week, we will run through an example for the reverse mortgage. We will again assume a $1 million home for a 70 year old. We will assume a 30% loan ($300,000). Assuming an increase in property value of 2.5% a year and a 20 year average mortgage rate of 9.5%, this 90 year old would have a $1.8 million loan and a $1.6 million property. Of course, the providers say they will cover the loss in value in such an instance, but always check the fine print with legal representation. Regardless, you will have no equity at age 90.

You may be ok with that if you have no need to leave a legacy, or your circumstances change and you don’t need the equity in your home to fund a move. Otherwise, that could provide a real problem for you.

However, if house prices increase by 5% a year (rather than 2.5%), at age 90 you would have a house worth $800,000 more than the loan. So not only would you receive a $300,000 lump sum but you would also have plenty of equity in the home to still use even after you pay off the loan.

A 3% increase in house prices in this example would see you with around the same equity in the house as the size of the loan. So no better off than in the 2.5% house price increase scenario really.

At a 4% increase in house prices, $400,000 higher house price than the cost of the loan.

A lot here depends on the length of the loan too.

Still with a 4% increase in house prices, you would still have around $700,000 worth of equity in your house (rather than $400,000 after 20 years).

Finally, the amount you borrow obviously matters too. Instead of $300,000, lets say you borrow $200,000. After 10 years you would have equity (after payment of the loan) of around $970,000 (rather than $700,000) and after 20 years still $970,000 (rather than $400,000).

hOW MUCH DOES THE VALUE OF YOUR HOUSE NEED TO INCREASE BY TO OFFSET THE COST OF a reverse mortgage LOAN?

Of course the fees alone look scary. And they are. But sometimes you can come up well ahead if house prices increase by a lot. It’s easier to come out ahead with a smaller loan and a shorter timeframe.

Just take a look at the examples below:

House gains needed to match a reverse mortgage loan that is 5% of a houses value

House gains needed to match a reverse mortgage loan that is 10% of a houses value

House gains needed to match a reverse mortgage loan that is 20% of a houses value

House gains needed to match a reverse mortgage loan that is 30% of a houses value

The riskiest scenario is taking out the largest loan (30%) over the largest period (30 years). You would need your house to increase in price by an average of 5.9% per year for 30 years.

If you get a reverse mortgage of just 10% the value of your house over 30 years, the house price gains required are just 2.2% per year.

Or instead of reducing the loan from 30% to 10%, you could reduce the 30% loan from 30 years to 15 years for the same impact in this example.

Decrease both the loan to 10% and the timeframe to 15 years and you won’t need any house price gains. Your loan won’t exceed the value of your property as long as it doesn’t decrease in price.

Do note we haven’t included the sales costs of the house in these examples, so the real percentage may need to be slightly higher dependent on how much it costs for you to sell your home.

But what if you aren’t happy with just meeting the costs of the loan? How much does your house need to increase in value to pay the reverse mortgage loan in full AND maintain the original equity in your home?

How much your house will need to increase in value to both pay off the reverse mortgage loan and maintain the original equity in the property on a reverse mortgage loan 5% of the value of the house at 10% interest rate

Obviously a big jump required from paying off the loan and having no equity left vs paying off the loan and having the original equity remain. Of course, one shouldn’t necessarily expect getting the income and keeping their property value but you never know. And it is good to see the range of outcomes required.

In the 30% loan for 30 year scenario, a jump in house price gains required from 5.9 to 8.3%.

A 10% loan over 30 years from 2.2% to 4.5%.

Final thoughts

Just like the Lifetime home retirement product, I see this as a last resort. It is very expensive.

If you need to supplement your income can you find a part time job, borrow from family, downsize house, get a boarder or reduce expenses? Try and exhaust all other options first.

For example, your family may rather you borrow from them than get a reverse mortgage, especially if they are part of your estate plan. They will likely inherit more from you if you borrow money from them than if you take on the high fees of a reverse mortgage.

If you do have to take on a reverse mortgage, then try and take on the least amount of loan as possible for the least amount of time as possible. Just because you can borrow more doesn’t mean you should. You saw on the loan balance and house price gains tables, the difference higher loans and more years can make.

Minimise the time and amount of the loan.

A reverse mortgage can work well if your house price returns are 5% or more per year. But if they don’t, then you can end up in a very bad situation indeed. Especially if your loan is 20 years or longer and more than 10% of the value of the house. That is a heck of a lot of risk to take on if you don’t need to.

For the illustrations here, we used a 10% interest rate, but changes in the interest rate can affect the outcomes greatly. Lower interest rates will mean the house price gains required would be less. Higher interest rates and gains required more.

It is a big decision, so it is smart to involve your family, Lawyer and of course financial planner as part of the decision making process.

Next week I will compare the two retirement income products that we have reviewed in the last couple of weeks. Lifetime home income vs reverse mortgage. To see which one will likely see you better off.

I have added an easy to use reverse mortgage calculator for you to have a look at your own numbers here.

If you need help with your personal retirement planning, then get in touch today.

The information contained on this site is the opinion of the individual author(s) based on their personal opinions, observation, research, and years of experience. The information offered by this website is general education only and is not meant to be taken as individualised financial advice, legal advice, tax advice, or any other kind of advice. You can read more of my disclaimer here

Reverse mortgages in New Zealand