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Federal government starts to ride the property boom with reverse mortgages

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By John Beveridge - 
Federal Government property boom reverse mortgage Pension Loans Scheme interest rate

The federal government’s Pension Loans Scheme allows a full-rate pensioner to receive a maximum income top-up that is equal to half of the age pension.

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Right under our noses a quiet revolution has seen the federal government start to join the rest of the country in riding the property boom.

After decades in which there were pleas for an attractive reverse mortgage scheme to improve the lives of asset rich but income poor retirees, the federal government’s Pension Loans Scheme (PLS) has finally filled that breach.

And it is proving very popular, having grown more than five times bigger in less than two years as retirees tap into the increasing value of their homes to pay for living expenses.

Feds will own homes

In the longer term, of course, these homes or at least a chunk of them will be owned by the federal government as the retirees eventually die and their estates are finalised.

In the 2018-19 financial year, there were just 768 people who had used the scheme but those numbers have exploded to reach 4,039 by the end of March this year, with every indication that the scheme will keep growing quickly as it develops new features – the most important being the no negative equity guarantee which is being added from the middle of next year.

That is an important change because with interest capitalised on these loans, the amount borrowed can balloon fairly quickly to consume the entire value of a property.

No negative equity guarantee will help popularity

The no negative equity guarantee means that the loan can only grow until the government owns the property outright but no further, which is an important distinction.

So far, the main users of the scheme have been full and part-rate age pensioners, although it is open to self-funded retirees who have reached the aged pension bracket.

It is estimated that about two-thirds of PLS participants are full-rate pensioners, with most of the rest part-pensioners with limited usage by self-funded retirees.

Under the scheme, a full-rate pensioner can receive a maximum income top-up that is equal to half of the age pension.

For a self-funded retiree, the maximum is equal to 1.5 times the full age pension, while part-pensioners can access an amount between those two extremes, depending on how much part-pension is received.

Payments don’t count for means test

The payments are not assessable for the age pension means test, which is probably why the scheme has so far been most popular with full or part pensioners rather than self-funded retirees.

At the moment, the loan can only be paid out as an income stream but after the changes are introduced in the middle of next year, users of the scheme will be able to get up to two lump-sum advances in any 12-month period, up to a total value of half of the maximum annual rate of the age pension.

Lump sums could increase attractiveness

The availability of lump sum payments is also likely to increase the attractiveness of the scheme, with many retirees wanting to access money to pay for larger purchases, such as a car or a home renovation.

The success of the PLS is interesting because a variety of reverse mortgages offered by banks and other financial institutions over many years have largely failed to get significant traction, even though there is thought to be a significant demand for this sort of product.

That may be because of controversies over how the loans were calculated and the speed at which home equity can disappear when interest is capitalised, particularly if interest rates are higher.

Interest rate is key

At the moment the PLS charges a variable interest rate of 4.5%, which is higher than many home loans but still cheaper than most commercial reverse mortgages.

With a house often being the biggest asset that a retiree owns, the need to tap that asset to provide for living expenses is obviously going to grow if the scheme is attractive enough.

It seems like the federal government has finally got the formula right and it is interesting to contemplate what the investment possibilities will be.

Depending on the continuing growth of property prices, the government could get a good return on their investment, particularly if the properties it lends against are well positioned.

However, there are risks on the other side, mainly if the borrowers live longer than expected, have property that performs poorly and have long ago maxed out their borrowings.