Conventional wisdom would have it that workers should retire debt free. But that may not always be the best way to go. What if retirees could hang on to debt to their advantage?
If the majority of your wealth is tied up in the family home, clearing a mortgage locks that equity up in retirement. Re-borrowing against the home is almost impossible without steady income. And unless you sell and downsize, a reverse mortgage is really the only alternative if accessing equity is required.
And it turns out that more Australians are exploring reverse mortgages to ease cash flow pressures in retirement. Surveys report that with more retirees concerned about income, enquiries and demand for reverse mortgages are growing.
However, the reverse mortgage market is complex and somewhat of a minefield, and can be overwhelming for those retirees considering going down that path.
Features, rules, and restrictions vary considerably among reverse mortgage products. Interest rates are typically higher than standard mortgage rates, and establishment, valuation, legal, and ongoing fees all add up. Early repayment of capital may be restricted or penalised, with overall flexibility in short supply. There may be additional insurance and property maintenance requirements. And the whole process can be confusing and unsettling.
An alternative strategy
Instead, by not wiping out a mortgage on the family home prior to retiring, a ‘line of credit’ can be set up to access equity and manage cashflow when retired.
Specifically before retiring, funnel as much savings as possible into an existing home loan with full redraw facility. Ideally the net loan balance will be close to zero by retirement. If no home loan exists prior to retiring, it may be possible to establish one while there is still income and capacity to service one. Then pay it down to build redraw.
The benefits of having an open loan facility in place to draw upon in retirement include:
1. Flexibility.
- Ability to fund one-off type expenses such as medical, home repairs, a car, or even travel.
2. Bridging income.
- Can provide income in early retirement before super becomes accessible, or until Age Pension entitlement.
3. Volatility Buffer.
- Enables super balances to ride out market volatility. Funds can remain invested in growth assets without needing to lock in losses in market downturns, by drawing on loan funds for income instead.
4. Bank of Mum and Dad.
- A means of being able to assist your adult children.
5. A ‘DIY reverse mortgage’.
- Supplement super fund pensions and/or the Age Pension, in a controlled and measured way on one’s own terms.
- Decide how much to access and when, controlling your home equity. Interest on funds drawn is paid at a competitive owner-occupied rate, and money can be repaid simply at any time.
- Avoids the pitfalls and complexities of a commercial reverse mortgage.
Note, that a redraw facility can be restrictive and controlled, and is best suited for lump sum type withdrawals. A mortgage offset account could therefore be another means to access home equity, offering maximum liquidity if regular cashflow is required.
Bear in mind though, that an offset account is basically a savings account linked to a home loan, and is therefore treated as a financial asset for Centrelink purposes. A redraw facility, however, allows access to funds already used to pay down a mortgage, and is exempt from the Age Pension assets test.
If preserving Age Pension entitlement is required with regular cashflow, then a combination offset/redraw approach could be considered. By topping up the offset balance with redraw lump sums at defined intervals, entitlement effects can be kept to a minimum.
It needs proper planning
Maintaining debt in retirement is not without risks and considerations. A redraw facility is not guaranteed, and lender rules can change. If the Age Pension isn’t an issue, the process can be simplified by just running an offset account. But ensure the mortgage can be 100% offset as that is not always the case and note that offset accounts are usually not available with fixed interest loans.
As seen in recent times, interest rates can rise rapidly, and without an offsetting increase in property value, equity can be eaten into faster than expected. And discipline is key, as easy access to redraw and offset accounts can tempt excessive spending. And there may be implications for estate planning, as equity could reduce for beneficiaries. As with any financial decision, proper risk/benefit analysis should be undertaken before entering into a particular arrangement.
Finally, if using debt to mimic a reverse mortgage, an exit strategy should be considered before commencement. A 'DIY reverse mortgage' can work well for early to mid-retirement years. But unlike a commercial reverse mortgage which is a lifetime arrangement, redraw/offset facilities are tied to a standard mortgage which has a defined term to expiry. It must be repaid eventually. At which point super and Age Pension cashflow needs to be sufficient, or assets sold either to downsize or move into aged care. Or transition to a reverse mortgage, having at least deferred this option, with interest savings and hopefully an increase in property value along the way.
Having flexibility in retirement is key and knowing that debt managed prudently is not necessarily a bad thing, it can provide another option for income. So that perhaps the pre-retirement mantra should shift from: “retire debt free” to “retire with flexible access to funds”.
Tony Dillon is a freelance writer and former actuary.