A Reverse Mortgage - A Handy Last Resort

What is a reverse mortgage?

Your home might be your biggest single financial asset. This is quite common among young people who are still building up retirement savings, but it can also hold true for people who are close to retirig or already in retirement.

In the past, retirees with insufficient retirement savings would have needed to 'downscale' -- sell their homes and move into a smaller one. In theory the smaller house costs less, freeing up capital for the retiree to invest and supplement their retirement savings. As a last resort, selling the house and renting instead could also be considered, but this is normally not preferable as you could be subject to above-inflation rental escalations, and you would forego the benefits of property value growth over time.

There can be some problems with choosing the downscaling option. A home is usually filled with happy memories -- giving this all up for a smaller house which may subconsciously be associated with the old age can be emotionally difficult.

In addition, in my experience clients often do not net as much money as they think they will from downscaling. The demand for smaller houses in retirement villages is high, resulting in relatively high prices. There can also be significant costs associated with property transactions – estate agent, transfer and legal fees, transfer duty and then moving costs can add up quickly.

There is now a new option available in South Africa. If you are older than 65 and your bond has been paid off, but you are still short of retirement capital you could consider a reverse mortgage.

Reverse mortgages have been used successfully in other countries for many years. In simple terms, you can borrow money against the value of your house. The money can be taken as a lump sum or as regular monthly payments. The amount of money that can be taken out will depend on a number of factors, such as your age and gender, the value of your property and even the suburb in which your house is located. It is very unlikely that you will be able to access more than 45% of the value of your house. There might also be an upper limit imposed on the Rand value of the reverse mortgage.

The downside of any loan is that you will pay interest on the outstanding amount. The “most powerful force in the universe”, compound interest, will be working against you, rather than for you. The interest rate that you will be charged could vary, but will be linked to the prime rate. Unlike most mortgage bonds, it is likely to be above rather than below the prime rate. If you are going to use a reverse mortgage, try and choose the monthly withdrawal option over the lump sum option – you will end up paying less interest.

The reverse mortgage will reduce the value of your estate upon your death. It may not be possible to leave your house to your spouse or children. Your estate planning might need to be reviewed in this case. Be aware that upon your death, your spouse is not assured of being able to continue living in the house. He or she will need to apply for a reverse mortgage in their own right.

In a worst case scenario, if the property market drops substantially, you might owe more than your house can be sold for. There are also some costs involved in setting up a reverse mortgage, such as bond registration costs and valuation fees.

In my opinion, reverse mortgages can be useful in certain scenarios but should be used as a last resort.

It is better to save from an early age than have to rely on eroding the value of your home in your golden years!

My advice is to obtain an impartial review of your investment plan or engage an independent, fee-based certified financial planner who is focused on your best interests and can provide impartial advice from an early age. If you cannot get a referral to a certified financial planner, visit the website of the Financial Planning Institute on www.fpi.co.za to select one.

Ian Beere, BCom BCompt (Hons) CA (SA) CFP, is a financial planner and business partner at Netto Financial Services. He was Financial Planner of the Year in 2007.