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Is equity release the answer to meeting the cost of aged care?
By Rachel Lane, Principal of Aged Care Gurus
T
here is a lot of talk at the moment about including the family home in the assessable assets for pension entitlement. The Productivity Commission made a number of recommendations about assessing the value of people’s home for the ability to fund aged care costs, including the establishment of a government back home equity release scheme. These recommendations didn’t form part of the Living Longer, Living Better Reforms and don’t appear to be part of the coalition’s plans for aged care reform either. That is not to say that accessing the equity in the family home is not a viable way to fund the cost of aged care. The idea of utilising the equity in your home to fund retirement and aged care costs is not a new one. There are a number of different ways people can release equity in their home: sell a share to a financial institution, sell a share to a private buyer (family member or through an investment vehicle) or borrow money against the value of the home without the need to make re-payments, this is commonly known as a reverse mortgage. Reverse Mortgages are the most well-known vehicle for releasing equity from the family home. Reverse Mortgages enable the borrower to withdraw either a lump sum, regular payment or a combination based on the value of the home and the age of the youngest borrower. The older you are the more you can borrow. Unlike a normal mortgage where you need the asset to borrow against and the income to meet repayments, payments are not required to be made until the end of the contract (normally on death of the borrower or sale of the home). This doesn’t mean that reverse mortgages cost the same as a normal mortgage, generally the interest rates are higher, the amount you can borrow is lower and because payments are not being made the level of debt increases at a much faster rate as you end up paying interest on interest. As at December 2012 more than 42,000 Australians had a reverse mortgage with total borrowings of around $3.5bn. Under the current system when someone uses a reverse mortgage to fund the purchase of an accommodation bond the net effect of the transaction is zero – they are borrowing against an asset that is exempt from their pension and ongoing cost of care (their former home) to purchase an asset that is exempt from their pension and their ongoing cost of care (their accommodation bond). Of course, if they wish to keep the exemption on their home indefinitely
and/or rent it they still need to pay a periodic payment on part of their bond and rent their former home. With the changes to the way the cost of care is calculated from 1 July reverse mortgages may have an important role to play in enabling residents to fund their costs. A Reverse mortgage can be taken as a lump sum or a regular payment, whether a resident will choose to use their home equity to fund their RAD or their DAP will depend on a number of factors including whether or not the borrowed funds are assessable for the care contribution. The changes between the current accommodation bond and the new Refundable Accommodation Deposit mean that the amount of RAD a resident can pay is capped at the published price and the amount of RAD paid is included in the calculation of assets for the care contribution. These changes will mean that residents whose home is valued higher than their RAD will need to think long and hard about the pension, cash flow and aged care cost associated with selling the home as well as the lost opportunity for income (rent) and capital growth. Let’s look at a case study to see how the different outcomes may influence a resident’s funding choices…
Case Study – Shirley Shirley is aged 85 and is widow. She currently receives the full age pension. She has a house valued at $800,000, Bank Accounts totalling $60,000 and Personal Effects worth $5,000. The aged care facility Shirley would like to move to has a RAD of $350,000 RAD or DAP of $63.36p.d.