Home Equity Release Schemes - A Means of Financing for Old Age

People aged 65 and over make up a large and growing proportion of New Zealand’s population.1  Home ownership rates among older people in New Zealand are high, but their incomes are, on average, lower than for younger age groups, so that many fit the description “asset rich, income poor”.

Essentially, equity release schemes provide a mechanism for home owners, over a specified age but without adequate loan servicing ability, to borrow funds by using the equity in their home as security.  Usually, interest payments are not required during the term of the loan nor is the loan repayable until the borrower either passes away or sells the security property.

Historically, New Zealand’s market in equity release products has been limited.  Recently, however, there has been an increase in the number of private participants offering equity release products.  It is expected that the potential for equity release in New Zealand is high, given the current and likely future social, economic and policy environment.

If you are considering an equity release product you will need to check it thoroughly to make sure that it is right for your situation.  This article aims to inform you about the types of equity release schemes available in New Zealand, some of the issues that you should consider and alternative ways that you can release value from an asset without using a commercial equity release product.  The issue of whether reverse equity schemes are desirable or not is closely aligned to views on inheritance.  The inevitable consequence of an equity release scheme is the diminution of the amount available to be bequeathed to subsequent generations.  As Judith Davey comments in her paper The Prospects and Potential for Home Equity Release in New Zealand:2

If older people set great store by bequeathing and younger people have strong expectations of inheriting then such schemes will not be attractive.  If, on the other hand, bequeathing is not considered important, perhaps because the next generation is well established financially, then older people might consider mobilising housing wealth to improve their current lifestyles.  Young people might be willing to accept a trade-off between inheriting and having to support elderly parents or relatives, either financially or by providing physical and social care.

Types Of Equity Release Schemes Currently Available In New Zealand

In New Zealand, the different options available include:

• traditional equity release mortgage and line of credit schemes;
• term loans;
• loan reinvestment;
• local authority rates postponement schemes; and
• annuity schemes.

Traditional equity release mortgage and line of credit schemes

With this option, you borrow an amount against your property.  You either borrow the loan amount in a lump sum, or draw down on the loan as and when you need the money.  In the meantime, the interest payments accumulate until either you die or the property is sold.  The amount you borrow is usually quite small in relation to the property’s value – this protects the lender in case they have to wait a long time before the loan (and the accumulated interest) is repaid.  You should borrow only what you need, and pay interest only on what you borrow.  The interest rate is higher for this type of scheme than it is for a normal home loan.  There are many variations on these types of schemes.  Some schemes allow for the repayment of interest during the term and some do not permit this.  Some schemes guarantee that a specified amount of equity always remains following repayment.  Other schemes guarantee that there will be no negative equity, and that you will never owe more money to the lender than the selling value of your property.  Some schemes have fixed terms while others continue for the life of the home owner or until the property is sold.

There are reasons for and against a traditional equity release mortgage or line of credit scheme for equity release.  In favour, you borrow only what you need, when you need it – that means you have more control over your financial commitment.  The interest cost may be lower than alternative equity release products and the provider's fees may also be lower.  The main disadvantage is that the amount available is likely to be relatively small compared to the value of your property.  Despite the relatively small amount that may be borrowed, it could still compound to a significant sum if you live a long time.

Term loans

A term loan is similar to a line of credit scheme except the loan has to be repaid at the end of an agreed term or when the loan grows to a fixed maximum percentage of the home value.  On maturity the house normally has to be sold and the loan repaid.  The things that you need to consider are similar to those discussed above as they are similar transactions.  However, there are a couple of extra issues.  In favour, these loans are suitable if you know that you do not want to stay in your home for life and are happy to sell when the loan matures.  Against, you are committed to the eventual outcome as the loan may need to be repaid before you are ready to move.

Loan reinvestment

In this case, you borrow on a mortgage from a traditional lender (like a bank) and reinvest a large proportion of your loan with a finance company offering a higher rate of interest.  The loan gives you access to a sum of money, while the income earned from the reinvested money covers mortgage expenses such as interest and fees.  The main advantage is that you can have a regular income from the difference in interest rates.  However, there are many disadvantages.  Namely, initial fees tend to be high, there are taxation issues to consider, you will have a large mortgage, and your risk may be with a single finance company – and, as we know, when this falls on hard times or goes into liquidation, your income may cease and you could lose your investment but you will still have the mortgage on your property.  Moreover, the amount you gain on interest may not be enough to cover your mortgage costs if the finance company’s rates and mortgage costs diverge.  Another point to consider is that the income is taxable and will affect “income-tested” government benefits.

Local authority rates postponement schemes

The Local Government (Rating) Act 2002 and the Local Government Act 2002 allow councils to postpone the payment of rates for residential ratepayers.  A rates postponement scheme, recently instigated by six local authorities, allows ratepayers aged 65 and over to apply for rates postponement for life.  Effectively, this is borrowing an equivalent amount to your rates each year.  Interest accrues on the outstanding amount and there may be establishment costs and ongoing management costs to pay.  Decisions to implement the scheme are made on a case by case basis.  All or part of the rates can be repaid at any time without penalty.  Outstanding balances may be transferred to another property in the same local authority area. If the total charges reach 80% of the property value, future postponement may cease.  There is a guarantee that no liability will exceed the value of the property.  The statutory charge afforded to unpaid rates takes priority over other secured loans.

The main advantage of this type of scheme is that you do not have to worry about finding the cash for rates increases (although the growing debt does accumulate as a charge against the property).  Set-up fees are generally low and the annual interest payable is usually reasonable.  A disadvantage of these schemes is that the loan is not transferable outside the area of the relevant local authority.  In addition, they have a maximum permitted percentage, so that when the threshold is reached, rates may become payable again.

Annuity schemes

These schemes provide a guaranteed payment, either for life or for an agreed period. In essence, you make a lump sum payment to an insurance company, which is usually borrowed, with the borrowing secured by a mortgage over your home.  In return, the insurance company makes regular, usually monthly, payments to you.  The payments are generally of a fixed amount, but are sometimes index linked.  They continue for a set number of years or until death, depending on the nature of the annuity.  A variation of this structure is where the home owner receives the annuity, but the lump sum premium is not payable until the borrower’s death.  This contingent liability is secured by a mortgage over the home.

The main advantage is the regular income for life or the term of the policy.  With joint home owners the annuity may continue until the death of the last survivor.  An annuity for life has the advantage of continuing, notwithstanding that the mortgaged property has been sold and the original loan, used to purchase the annuity, has been repaid from the sale proceeds.

The chief disadvantage with annuity schemes is that they are not tax effective. Under the annuity scheme structure the home owner borrows to purchase an annuity but the interest cost is non-deductible.  While the money received from the annuity is not taxable to the home owner, the income component of the investment to fund the annuity is subject to tax (currently 33%).  Some annuity schemes also have the disadvantage that they are not index linked; hence inflation erodes their value over time.  Moreover, if you die too soon you may not benefit from the initial cost outlay in purchasing the annuity.  A further consideration is that if you receive an “income-tested” benefit from the government (for example, a “young spouse” New Zealand Superannuation payment, residential care subsidy or a widow’s pension) under the Social Security Act 1964 the annuity will be treated as “income” even though it is not subject to tax. 

Issues To Consider

Family interests and the impact on your estate

The likely effect of an equity release scheme is that monies available for distribution under your Will, will be reduced.  You should consider discussing the particular equity release scheme that you are thinking about with members of your family before entering into it.  Your children might be willing to provide you with financial assistance during retirement in the knowledge that, when you die, they will inherit the house.  However, if you do decide to enter into a family arrangement you should get legal advice about formalising the arrangement so that everyone involved is protected.  You will also need to make sure that the family arrangement is taken into account in your Will.

Costs

Interest rates

Just as you have to consider interest rate changes when you are getting an ordinary house mortgage, you also have to take them into account with equity release products.  Is the interest rate fixed or floating?  If it is fixed, is it fixed for the life of the loan or may it change before then?  If it is fixed and you repay early is there a penalty for early repayment?  If it is variable, is there a published basis on which the rate is set, for example, pegged at 1.5% above average floating rates?

Fees

As well as interest charges, there are several other costs you will be liable for when you get an equity release product.  It is also important to find out whether the provider has the right to change the fees they charge for future services such as extra draw-downs or termination.  For example, you may be expected to pay initial valuation fees as well as a valuation fee every few years to check on the changing value.  The provider may charge a “placement”, “arrangement” or “application” fee.  Your lawyer will charge fees for advising you in relation to the legal document that sets out the terms and conditions of the equity release product.  You may have to pay the provider’s legal fees as well.  You will also need to ascertain from the provider whether they charge an early repayment fee or “break” charges.  Likewise, there could be charges for administrative “housework” during the loan.  This might include varying the terms, replacing a property or discharging a borrower on separation, death or sale.  You may also be asked to pay extra fees for further draw-downs.

Buying and selling

If you release equity from the value of your home, you may find there are extra costs when you sell your home and buy another one – this is because of the costs associated with transferring your mortgage.  You might also have to pay back the loan connected with the equity release product as soon as you sell your house, which could reduce the amount you have to spend on your new home.  You need to make sure that you can transfer the equity release security when you sell your property and buy another.  While you might want to repay the equity release amount, it is better if you have a choice about whether or not to do so.  Likewise, if you are moving into a retirement village, you should also check whether the retirement village property itself can be mortgaged in the same way as your former home and whether you can transfer your equity release loan.  It may be best for you not to use an equity release product until you are in the home in which you expect to live for the rest of your life, in other words, your “final” home.

Is the provider secure?

You should be confident that the provider that you are dealing with will be around for the long-term, especially if you expect to receive a regular annual amount for your living expenses or plan to borrow more in the future.  Your lawyer can assist you with finding out who owns the business.  A provider with a successful track record or a strong balance sheet may be less risky than a provider with no track record at all.

Choose a flexible product

Try to choose a product that gives you flexibility.  For example, will you be able to decide whether or not to repay the equity released?  Can you pay off your provider and choose a cheaper, more flexible product if one becomes available?  Are there interest penalties or fees involved in paying off the first product?  If so, what are they?

Find out the minimum and maximum amounts you can borrow

You might be required to draw down a minimum amount to start with, and subsequent instalments may also have minimums.  The provider will usually specify a maximum that you can draw down at any one time.  It will often be a set proportion of the property’s value, and the amount may increase as you get older.

Find out whether you could lose your property

The equity release provider will have a legitimate interest in protecting its security, and will want its money back at the end of the arrangement.  So, you might find the provider requires the property to be fully insured.  Or, if you do not keep the property in good repair, the provider might take steps against you to protect its investment.

If you have a partner with whom you own the property, does anything happen to the equity release product when either of you die?  Does the survivor have to pay it back immediately?

Are there any other circumstances in which the provider could take some action against you to enforce its security?  If the worst came to the worst, could you even lose your home?  If so, what would have to happen before you could find yourself on the street?

Alternatives To Equity Release Products

There are several ways in which you can release value from an asset without using a commercial equity release product.  For example, you might choose to rent part of your home, subdivide your property, trade down by moving into something smaller and cheaper, sell the property to a family member or enter into some other type of family arrangement.  Your lawyer will be able to advise you in relation to the legal implications of any of these options.

In Summary – Is Equity Release For You?

For more information about equity release including the advantages and pitfalls visit the Retirement Commission’s independent website http://www.sorted.org.nz/life-stages/60plus/equity-release.  In particular, there are two very useful checklists of questions for someone considering an equity release product.  However, the writer strongly recommends that you seek independent legal advice before actually taking up an equity release product, so that you fully understand the nature of the obligations that you are entering into, the impact it will have on the value of your estate, the likely costs involved, now and in the future, and any risk that there might be to you or your partner’s future security.

1. At the time of the 2006 Census of Population and Dwellings they made up around 12% of the total usually resident population.  Over the next 25 years, the number of people aged 65 and over is projected to rise to around 20% of the totally resident population.  [Source: “Older New Zealanders – 65 and Beyond”, May 2004, Statistics New Zealand Te Tari Tatau, Wellington, New Zealand.]

2. Source: “The Prospects and Potential for Home Equity Release in New Zealand”, Judith Davey, New Zealand Institute for Research on Ageing for the Office of the Retirement Commissioner, March 2005.

3. The following councils are known to provide a rates deferral scheme: Rotorua District Council; South Wairarapa District Council; Masterton District Council; Kapiti Coast Council; Western Bay of Plenty District Council; Far North District Council; Rodney District Council; Thames-Coromandel District Council; Waikato Regional Council; Gisborne District Council; Marlborough District Council; Nelson District Council; Ashburton District Council and Queenstown District Council. 

© Langley Twigg

Email: nigel@langleytwigg.co.nz
Website: www.langleytwigg.co.nz

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