A review of the $2.5 billion reverse mortgage market by the Australian Securities and Investments Commission (ASIC) has found a number of benefits of this type of loan, such as seniors having the ability to live a more comfortable retirement, but oftentimes lenders are not conducting proper investigations into the long-term financial health of prospective borrowers, who could be affected by rising interest rates and declining property prices if left in the dark about risks.
Reverse mortgages, also described as “equity release” products, allow Australians over the age of 65 to access finance using the equity in their homes while living in the property. It is designed for borrowers that are asset-rich but cash flow-poor.
However, as ASIC has noted, reverse mortgages tend to have higher establishment and service fees, as well as higher interest rates (around 2 per cent more than standard home loans). As they generally don’t require repayments until the borrower sells the property or dies, the interest compounds over time, making the outstanding bill on a reverse mortgage larger than expected.
ASIC’s review into reverse mortgage lending, which drew on data from 17,000 loans, found that many borrowers had a “poor understanding of the risks and future costs” of the loan and failed to consider how the reverse mortgage could impact their ability to fund future needs.
As the corporate watchdog explained, following regulatory changes in 2012, borrowers can never owe a lender more than the value of their property and can stay in the home until they die or move out. However, with changing economic conditions and borrower requirements, home owners could be left with insufficient equity to pay for longer-term needs like aged care.
In fact, 63 per cent of borrowers could end up with less equity than is required to cover the upfront cost of aged care by the time they reach 84, according to ASIC’s report.
“But our review shows that lenders and brokers need to make inquiries that would lead to a genuine conversation with customers about their possible future needs, not just a set of tick boxes on a form,” ASIC deputy chair Peter Kell said.
The corporate regulator also noted that the reverse mortgage market has shrunk significantly since the global financial crisis, with just two credit licensees providing 80 per cent of the dollar value of new loans between 2013 and 2017.
Over those five years, Bankwest, Commonwealth Bank, Macquarie Bank, Heartland Seniors Finance and Westpac lent 99 per cent, but Macquarie Bank and Westpac exited the market in late 2017.
The market has shrunk at the same time as consumer demand has grown, ASIC noted, with lenders’ exposure to reverse mortgages rising from $1.3 billion in March 2008 to $2.5 billion in December 2017.
As of 2014, only 62 per cent of couples and 38 per cent of single Australians were headed for a comfortable retirement, the regulator added.
However, ASIC has found that borrowers don’t always factor in their future needs, with many at risk of being left short should the interest rate on the loan rise or property prices stagnate.
The average self-funded upfront cost of aged care for one person is $380,000; however, if property prices stay the same and interest rates rise by 3 per cent, only 24 per cent of borrowers will have at least $380,000 by 84, ASIC found.
If both property prices and interest rates stay the same, only 34 per cent of borrowers will have enough for the upfront costs.
ASIC noted that the borrowers surveyed as part of its consumer research also did not express concern that the compound interest charged on the loan could make it harder to make future payments.
This is where lenders come in, but according to the report, 92 per cent of loan files contain no evidence of the broker or lender having considered the future needs of the borrower in sufficient detail.
“Our loan file review indicated that the application processes of all five lenders focused primarily on the borrower’s short-term objectives, while limited or no attention was paid to their possible future needs,” ASIC said.
Lenders and intermediaries’ reticence to engage with or lend for reverse mortgages was often put down to the reputation of reverse mortgages as a means of financial abuse and the need to guard against the occurrence.
All five lenders’ contracts had terms that have the “potential to be unfair” in that they absolved the lenders from any responsibility for irresponsible conduct, ASIC claimed.
Clauses granting lenders the power to unilaterally vary conditions without the consent of the borrowers and others allowing the lender to respond disproportionately to inadvertent borrower misrepresentations were flagged as problematic.
“Although our findings indicate that reverse mortgages helped most borrowers achieve their immediate financial goals, we also identified several actions that we will require lenders to adopt to ensure that loans are not unsuitable for the longer-term needs and objectives of borrowers,” ASIC concluded.
Heartland responds to ASIC review
Commenting on the report, Australia’s third-largest reverse mortgage lender, Heartland Seniors Finance (HSF), a subsidiary of New Zealand banking group Heartland, said that it is committed to detecting and preventing elder abuse, as well as to ensuring that customers are making informed decisions.
As such, Andrew Ford, CEO of HSF, said in a statement that Heartland “is very much aligned with ASIC in this respect” and claimed that HSF has already made a number of changes since the commencement of the review. It has also agreed to participate in an ASIC working group to improve lending practices, the CEO added.
The CEO went on to praise ASIC’s report for being “very thorough” and “balanced”, highlighting the regulator’s positive findings.
Mr Ford said: “The report states that all ‘reported feeling satisfied that their reverse mortgage had enabled them to address their immediate financial objectives’, with borrowers interviewed indicating that a ‘reverse mortgage relieved the stress of finding ways to pay for current lifestyle expenses or larger expenses, such as maintaining a vehicle, refurbishing their home or managing other debt’.”
This year’s federal budget included a government-backed reverse mortgage scheme with a rate of 5.2 per cent, lower than commercial rates for similar products that start at 6 per cent per annum.
However, no lump sums are provided under the scheme; rather, it is intended to be a steady stream of income that is capped at $11,799 for singles or $17,787 for couples per year.