The cost-of-living increases in New Zealand since 2021 have been leaving many Kiwis feeling the pinch. While the Consumer Price Index has relaxed from its most recent peak of 7.3% in the 12 months to June 2022, many New Zealanders who are at, or nearing, retirement age are finding that their Superannuation or other income sources are failing to meet the rising costs of:
This reflects the not uncommon situation of being asset rich, but cash poor. As a result, people in this age bracket who own debt-free property may be looking for a way to free up capital to supplement their income. One method of doing so is a reverse (equity) mortgage.
A reverse mortgage is a type of loan specifically aimed at those in the over-60 age bracket, which releases equity in their residential property over time. This type of loan typically applies only to the borrower's place of residence however some lenders will allow the security to be a rental property or holiday home. The property in question must be debt-free, or nearly debt-free.
A reverse mortgage is registered against the title to a property, in a similar manner to a standard mortgage. The loan documentation can name a borrower (or multiple borrowers, if the home is owned by more than one person) as well as nominated residents (for example, a spouse or partner who resides in the property but is not named on the title).
Unlike a traditional mortgage, in a reverse mortgage, the funds are not drawn in a lump sum. While an initial drawdown sum is usually required, the borrowers can request additional advances only when needed or can elect regular advances.
To limit the reduction of equity in the property for the borrowers’ future needs, the maximum loan amount at any given time is calculated in reference to the age of the youngest borrower: the percentage of the home’s value able to be borrowed increases as the borrowers age.
With a reverse mortgage, a borrower is not required to make regular repayments of principal or interest (although they may elect to), and they are not penalized for early repayment.
Instead, repayment of a reverse mortgage occurs either:
The principal sums advanced, together with compounding interest (which is at a floating rate), are repaid to the lender, with the surplus paid to the borrower (or their estate).
If it is intended that theborrower/nominated resident retains the house but lives elsewhere, the reverse mortgage would need to be repaid by other means (e.g., savings, or alternative lending).
In these circumstances, the funds would be repaid via a sale of the house or could be repaid prior to/ without a sale, if the estate capital allows for it.
The borrower can elect to repay the full amount at any time, without attracting any early repayment penalties, due to the floating interest rate.
The biggest benefit of a reverse mortgage is that it allows an individual to remain in their home, while providing access to funds as needed to supplement their living costs.
New Zealand’s current reverse-mortgage providers also provide a guarantee that a borrower cannot end up in a negative equity position (where more is owed to the lender than the property is worth): if the loan balance exceeds the home value at the repayment date, the borrower (or their estate) will not be called upon by the lender to repay the shortfall.
Another benefit of a reverse mortgage is that the borrower retains legal ownership of the property and is therefore able to reap the benefit of any increase in the property’s value during the currency of the loan. This may in turn help to limit or off-set any reduction in the borrower’s equity.
The interest rates in a reverse mortgage are often much higher than standard mortgage interest rates. They are also floating, which means they are subject to a high degree of fluctuation, and interest is compounding (meaning interest becomes payable on any unpaid interest). When combined with the lack of mandatory repayments, the loan balance may become subject to a huge blow out, which could severely diminish the borrower’s equity when it comes time to sell/ repay the loan. In the case of an Estate, this could leave the borrower’s family with nothing to inherit, or at least less to inherit.
If the housing market is in a downturn at the time of sale, the cumulative effects of the high and compounding interest could have significant impact on the borrower’s ability to afford alternative living arrangements. Often, the entry costs for a retirement village are on par with the sale value of a home: any repayment required under a reverse mortgage may prevent the borrower from affording this.
There are also lender fees associated with obtaining a reverse mortgage: initial fees, ongoing fees; fees for additional drawdowns and fees payable when the mortgage is repaid. This is in addition to the legal fees required for the mortgage to be registered and later discharged.
A reverse mortgage may limit the borrower’s freedom in relation to the property or their future plans. Once a reverse mortgage is in place, the borrower would not be able to move into care or rent out the property to travel without first repaying the loan.
In addition, lenders can have quite prescriptive requirements regarding the upkeep of the property. These upkeep requirements may limit the practical benefit the borrower receives from the increased cashflow a reverse mortgage provides.
Obtaining a reverse mortgage is not a decision to be made lightly. It is therefore vital that you obtain legal advice prior to agreeing to anything. While for some a reverse mortgage is an effective means to an end, for others it could present a significant risk to their (and their family’s) future economic position and the lifestyle options available to them.
If you are considering a reverse mortgage, our specialist property team at McMillan&Co. are happy to discuss your situation and talk you through the process, as well as possible alternatives to help you make the right decision for your circumstances and needs.
Emily Robertson, Senior Solicitor
emily@mcmillanco.nz
“McMillan&Co. incorporates the practices of David Polson, Roger Barrowclough, Gerald Wilson, Joss Miller and McKinnon Aitken Martin.”
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