For most Australians, the family home is their single largest asset, and it is more valuable than ever.
Yet few retirees use the equity in their home to help fund their retirement, instead passing it on in full as an inheritance to the kids. This wasn’t such a problem 30 years ago, when the typical home cost only two to three times the median worker’s wage. But decades of rapidly rising property prices mean the median house now costs about 10 times the median wage, and even more in Sydney and Melbourne.
Many retirees live incredibly frugally while sitting on enormous nest eggs. Younger generations are spending a larger share of their lifetime earnings to pay off a house, or using the super to clear the mortgage at retirement.
Unless they become more comfortable with using their home equity in retirement, Australians will have lower living standards in working life and retirement while passing on even larger inheritances to their children and grandchildren. That’s why the federal government’s rebranding of the Pension Loans Scheme as the Home Equity Release Scheme is an important step.
Private providers of reverse mortgages have been around for decades, but the idea hasn’t caught on. The big banks worry about the reputational risks of foreclosing on grandma’s home, the interest rates offered have been unattractive and risk-adverse retirees are suspicious of taking on debt.
The Pension Loans Scheme allows retirees effectively to draw equity out of their home up to a maximum value of 150 per cent of the Age Pension. The equity release payments are made by Centrelink, are not taxable, and don’t count towards the Age Pension income test. The outstanding debt accrues with interest, which the government recovers when the property is sold, or from the borrower’s estate when they die.
Even using quite small portions of home equity can substantially improve retirees’ incomes. For instance, a typical retiree who uses the scheme to withdraw $5000 in home equity can boost their income by 17 per cent. The accruing debt would account for a modest share of a median-priced home, even if equity release continues for decades.
But the scheme has not proved popular; right now it has only about 5100 participants. The recent Retirement Income Review showed that retirees generally are hesitant to spend down their capital, including their superannuation and home equity. So the government is making changes designed to make the scheme more attractive.
First, the branding. The scheme is open to all Australians 66 or older who own real estate – not just to pensioners. Yet the original name implied only pensioners could qualify. Calling the fortnightly payments a loan, while strictly correct, discouraged many debt-adverse retirees. In practice, the scheme offers people early access to the equity tied up in their house.
The second change is to the interest rate offered. The former scheme charged 4.5 per cent on the outstanding loan. Under the renamed scheme, that will drop to 3.95 per cent from January 1. The new, lower interest rate will make the scheme more attractive, but it is still too high. The government can borrow for 10 years at an interest rate of only 1.6 per cent. The risks of the scheme to government are low: few, if any retirees, are likely to borrow more than the value of their house, leaving the government to foot the bill.
Chances are that an expanded scheme, even with a drastically lower interest rate, will boost the budget bottom line. Many retirees won’t be convinced by these changes: some will worry about the cost of the scheme should interest rates rise; others that they’ll be left without any inheritance for the kids.
So the government should cap the interest rate for the life of the loan on take-up or guarantee that a modest share of the home, say 25 per cent, will be ring-fenced from the debt when the home finally is sold. Such guarantees would be relatively cheap for government to offer but would go a long way to overcome the reservations of risk-adverse retirees.
Home equity release could substantially boost Australians’ retirement incomes and lower inheritances. But convincing them to take it remains a challenge.
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