Unlock home savings to fund old age
The Australian Newspaper 25 January 2011 Author: Prof. Ian Harper
AGEING baby boomers are haunted by two questions: will I have enough money to live comfortably in retirement; and how will I pay for aged care when the time comes?
Earlier generations of Australians trusted governments to meet their needs on both fronts. Baby boomers know this won't work for them because there are too many of them and not enough younger workers to pay the necessary taxes.
In any case, baby boomers are used to paying a bit extra to get what they want and aren't averse to contributing private resources to top up public support. This is just as well, according to the Productivity Commission's draft report, Caring for Older Australians, released last week, because public resources won't stretch far enough to fund adequate aged care for the growing numbers of older people.
While the commission's focus on funding aged care is welcome, the problem extends to funding adequate retirement income as well. Access Economics figures show most Australians have nowhere near enough superannuation to fund an adequate living standard in retirement. Most of us, especially baby boomers, will continue to draw at least a part-pension in retirement.
So it's not just the looming burden of aged care for growing numbers of older Australians that has Treasury boffins worried. It's the fact that government outlays on the age pension won't fall anywhere near as much as we thought they would with the introduction of compulsory superannuation. This is partly because the superannuation guarantee contribution has remained at 9 per cent of salary and wage income rather than the 12 per cent it was supposed to have reached by now.
As the Productivity Commission draft report helpfully points out, it's time for some hard thinking about how to make ends meet for older Australians. It is especially pleasing to see the commission pick up the idea of home equity release. In fact it goes so far as to recommend a government-backed scheme to encourage more people to consider drawing on equity in their homes to fund their aged-care needs.
Finding a way to release equity from people's homes without having to sell outright would allow them to contribute more of their savings towards their desired standard of living in retirement as well as their aged care. In particular, it would mean people could more often choose to stay in their own homes and pay for services to be delivered to them, at least until they became too elderly or frail to be cared for properly outside a dedicated facility.
The idea of tapping home equity to supplement income or purchase a place in an aged-care facility is not new.As an alternative to selling the house, reverse mortgages have been available for some time. This is a way of borrowing money against the security of the house with the intention of repaying the debt when the house is sold (generally once the occupant has died or moved into permanent residential care).
People have been wary of reverse mortgages because they leave the homeowner carrying the risk that adverse movements in house prices and/or interest rates may absorb all the equity, leaving nothing for a bequest or, worse, possibly triggering the need for the house to be sold while the occupant is still living in it.
This is where the Productivity Commission's discussion of alternative equity release products is helpful. Reverse mortgages are not the only way to release part of the equity in a home while still living in it. Debt-free equity release or "home reversion" is an alternative mechanism that overcomes the risk of interest rates or house prices moving against the homeowner.
Debt-free equity release involves the homeowner incurring no debt as equity is released. Essentially, the homeowner sells a part-interest in the future sale proceeds of the home. The purchaser of that interest takes the risk that the home will be worth enough at the time it is sold to make the deal worthwhile from its point of view. In the meantime, there are no mortgage repayments nibbling away at the value of the home, because there is no debt.
Debt-free equity release is an innovation in Australian financial markets. It can expand the choices open to older people by granting them access to the savings tied up in their homes without obliging them either to sell or to incur further debt.
But if it's such a good idea, why is there any need for government backing, as the Productivity Commission recommends?
People are rightly wary of a relatively new financial product, especially when they are older and naturally more cautious about their biggest asset. However, demand for the product is not the real problem. A debt-free equity release product is already on sale for homes in inner Sydney and Melbourne through a single private supplier in partnership with a regional bank.
The problem is supply. For the product to be available beyond Sydney and Melbourne, institutional investors need to recognise a new asset class, namely, pooled residential real estate. This is new territory for investors as much as for homeowners, and it is here there is a bellwether role for government, as the Productivity Commission rightly identifies.
The government needs to consider how best to encourage private investors, including superannuation funds, to invest in diversified claims on the future sale proceeds of people's houses. It may simply need to prime the pump, as it has done in the market for residential mortgage backed securities, to encourage the private sector to step in.
An active market in debt-free equity release offers greater choice to older Australians in retirement and advanced age, as well as creating a new asset class for Australian institutional investors. The government stands to gain from a reduced call on public funds, which is why the Productivity Commission calls on it to make the first move.
Ian Harper is a Director of Access Economics. He co-authored a report on debt-free equity release for Homesafe Solutions Pty Ltd that is cited by the Productivity Commission in its draft report.
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