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Reverse Loans – could reverse all over you!

Recently, on 29th December 2007, The Law Society had a publication in the Herald reminding us just how expensive and dangerous Reverse Annuity Mortgages can really be. Unfortunately, the 29 th of December would see a lot of people at the beach or hung-over after a good Christmas and not likely to read such an important report. Whilst not against the companies and providers of Reverse Annuity Mortgages, I do think the peddling of them as a panacea and easy cash by some financial providers will soon be found to be irresponsible unless the client has had good independent advice.

Some of the names are:
    Reverse Loans
    Reverse Annuity Mortgages
    Equity Release
    Reverse Mortgages, and so on
In short, it is borrowing a lump sum against your property, and allowing the interest and all costs to accrue at compound rates against your real estate assets, and accumulate they will.

There was an example given of a $30,000 loan at an interest rate of 11.14%, which is about the normal rate. This is how it looked:
The original loan $30,000
Year 1 $33,484
Year 5 $51,966
Year 10 $90,014
Year 15 $155,921
Year 20 $270,085
Year 25 $467,838

In other words, if you pay no interest on the original $30,000 borrowed, the accumulated loan and interest is an amazing $90,014 after just 10 years.

If you invest $30,000 at 11.14% for 10 years, not taking the interest out, the amount will grow to $90,014. Not a bad investment is it!

Compound interest is supposed to be the 8th Wonder of the World. And it is, because if you can avoid taking the money out, then you are going to make a lot of gain.

I have been asked to arrange a Reverse Annuity Loan for an elderly friend. I was opposed to it, but in the end I suggested that she borrow the $30,000 and pay the interest bill from other income source, which she had. This is $3,000 per annum or about $60 per week in interest. The capital sum does not grow. Another option she could consider is asking the family to 'share pay' the interest bill. In this case, her four children could pay $15 per week each to cover the interest cost. I also believe in a situation such as this that the house property could be transferred to a Family Trust and then the children would have an incentive to pay the interest bill to keep the debt from accruing against the house.

Do people really need the money? Or is the Reverse Annuity Mortgage just for consumption, travel and so on. Once again, I am not against people taking equity out of their houses, but the process has got to be managed with the correct advice. Is it just more use of credit, the results of which we are seeing in the United States?

The Law Society is suggesting that prospective borrowers need to get independent advice, and who should give that advice? The provider of the funds is not independent. The Retirement Commission said a code is being developed by their office for senior citizens which could become law next year. How will the issues be defined, and how will they be administered?

Furthermore, you need to be sure of how long you think you are going to live. You could easily live longer than you expected only to be faced with financial problems later in life. Yes, your house may continue to rise in value covering some of the interest accrued, but will the financial pressure force you to sell later and will you then have enough equity to sell your house and buy a cottage in a rest home village.

In summary, Reverse Annuity Mortgages need to be a loan of last resort. Borrowers need to be old and sure they are not going to live too long to avoid the financial trouble that may occur later.

I believe a good option is to transfer the house to a Family Trust with the children as beneficiaries and then they can possibly service the interest on a loan to avoid accruing to the asset. I also agree that independent financial advice must be mandatory, but again, I question who gives that advice and does the client have to adhere to it anyway? And finally is it just easy credit for consumption, and is there another way?


 

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