Benefits of getting a reverse mortgage
Many thanks to the reader who pointed out that the exemption of the family home from the age pension assets test is not the only reason for the attraction of using a reverse mortgage or other borrowing against the family home. As highlighted last week, the severe 7.8 per cent age pension assets test taper rate can result in retirees losing more in age pension payments than they can gain from investing the surplus proceeds from the sale of the home.
Especially in major cities, the longer-term appreciation in value of the family home has been a substantial source of family wealth for many Australians. As long as property prices continue to increase - even if only to match inflation - continued ownership of the family home will provide after-tax returns comparable to or better than conservative investments.
Compared with paying rent or being faced with a loss of age pension from downsizing, the interest on a reverse or other mortgage can be a bargain because of continuing growth in the value of the home. Indeed, despite the costs involved in servicing debts, the benefits of retaining ownership of the family home even for a few extra years can be and has been significant.
The interest costs of reverse mortgages and similar lines of credit are capitalised and increase the outstanding debt. Nevertheless, the tax-free appreciation in the value of the property can and often does improve the net wealth situation of the home owner or their heirs who have up to two years to retain the tax-free status of the gain.
In practical terms, the exemption of the family home from capital gains is a key factor in deciding whether to downsize or continue to remain in the family home. Having the ability to borrow against or withdraw money from a mortgage offset account greatly expands the financial options available to retirees.
While very few people like voluntarily paying additional tax, the severity of the age pension assets test increases the attractions of selling an investment property purchased after September 1985, especially compared with freeing up cash from downsizing.
Retained as an investment, Centrelink values investment properties at their market value including any unrealised capital gain. But when sold, the asset test valuation falls because of the capital gains tax payable on the proceeds.
Partially funding retirement using a reverse mortgage can also reduce the negative impact of downsizing later.
Instead of ending up with surplus funds subject to the assets test, part of the proceeds will be needed to pay off the outstanding mortgage. The longer the sale is delayed, the smaller the net proceeds will be unless, as is possible, the property appreciates in value faster than the outstanding mortgage.