How to use home equity to top up your pension
We often talk about Australia having a three pillar retirement system:
- A means-tested and government-funded age pension
- Mandatory private savings through the Superannuation Guarantee arrangements
- Voluntary private savings, often also in superannuation
However, this ignores the investment in Australian residential real estate that ties up an estimated $7 trillion in capital. The value in their own home represents most of the wealth of the majority of retirees.
Unlocking this capital may hold part of the solution to relieving the looming shortfall in retirement savings, and should be considered a fourth pillar of the system.
With the recent tightening of the assets test to qualify for the age pension, many retirees will feel the squeeze of having less money to live on.
The Government has also doubled the so-called ‘taper rate’, where pension payments ‘taper off’ at the rate of $3 per fortnight for every $1000 of assets above the minimum threshold ($250,000 for a single home-owner and $375,000 for a home-owning couple).
It is estimated that 300,000 Australians are receiving a lower pension as a result of these changes, and 100,000 will lose their pension completely.
Retirees looking for more cash could consider unlocking equity in the family home by taking out a reverse mortgage, where money is borrowed against the value of the house either as a lump sum or as an income stream.
However, the product has not been popular because with no repayments required, the capitalising interest on the loan can build up over time, and many people do not want to reduce the value of their estate left to their children. Several banks no longer offer the product, but there is an alternative that is often overlooked.
How does the Pension Loans Scheme work?
The Pension Loans Scheme (PLS) is administered by the Department of Human Services. The Scheme allows asset-rich but cash-poor retirees, who own their home but miss out on maximum pension payments, to top up their pension income stream via a loan from the government.
Retirees may be eligible if they (or their partner) are of age pension age and have real estate to offer as security, but they receive only a part-pension. The amount of the loan available may depend on the amount of collateral offered and the age of the retiree.
The loan can be paid back at any time but must be repaid either when the house is sold or from the owner’s estate when they die. In other words, the loan does not need to be repaid during the life of the pensioner if their home is not sold prior to their death.
This top up payment is available to people on any of the following pensions:
- age pension
- carer payment
- disability support pension
- widow pension
- wife pension
For full eligibility criteria, check the PLS website.
The pension loan has a 5.25% interest rate, which is applied to the outstanding loan balance each fortnight. This rate is higher than most people can achieve on their bank deposits, but it compares favourably with commercial reverse mortgage interest rates of over 6%.
The uptake of the PLS should increase as the number of Australians that qualify for only a part-pension increases, especially as their pension payments fall and they want to maintain the same level of income. Provided, of course, they even know the PLS exists!
Calls to broaden eligibility
One of the problems with reverse mortgages is that many banks are unwilling to provide the product, reducing its general acceptance.
Some have argued that the PLS should be made available to all Australians of pension age, rather than only those on a part-age pension. It would boost retiree income without a cost to the budget as pensioners use the equity in their home.
Most economists would argue that private sector financial intermediaries are the most appropriate distributors of credit across the economy.
However if the recent cuts to age pension payments begin to bite and the population demographic continues to age, a less traditional economic principle might find favour. There is potential for an arrangement like the PLS, or a more popular home equity product provided by banks, to become a significant fourth retirement pillar.
In the meantime, the PLS offers a competitive interest rate on flexible terms for those eligible, and may provide a valuable income top up for many people on a pension in retirement.
How do you plan to support your retirement? Would you be interested in a pension loan?