Part 1 "Home Equity Conversion" (HEC) Schemes – what you need to know

How do HEC schemes work?

For many older people, the money invested in their homes, the equity, is the major part of their net wealth. This wealth helps to reduce costs, but the money tied up in a home is not available to help with house maintenance or other living costs. HEC schemes, sometimes called home equity release loans,enable some of the financial equity in the home to be made available to the home owner, either as a lump sum, a periodic payment, or an annuity.

Under HEC schemes, the home owner, the “borrower”, applies to the HEC scheme, the “lender”, to be paid an amount, the “loan”, and the “lender” in return, is empowered to secure the “loan” against the property. The eligibility of HEC borrowers is largely dependent on their home having a significant value. The funds advanced and the accumulated interest does not have to be repaid until the owner sells the property or dies.

Typically, a HEC scheme will make a loan available to people over 60 years of age who own a property over a certain value. Most loans have similar features.

• The loan will be limited to a percentage of the value of the house.
• The percentage increases with the age of the borrower.
• Interest is accumulated on the loan at a variable interest rate.
• The interest rate is generally a given percentage, for example 1.5% to 2%, above the major banks' variable mortgage rates.
  Home owners are given guaranteed residency in the property. The loan and accumulated interest is not repayable until the owner sells their property or dies.
• A no-negative equity guarantee ensures that the value of the loan will never exceed the net sale proceeds of the property.

There are three main types of legal structure for HEC schemes: reverse mortgages, home reversions and shared appreciation schemes.

Reverse Mortgages

Reverse mortgages enable older home owners to borrow against the equity in their property. Home owners are able to draw capital sums or periodic payments, annuities or lines-of-credit. The total amount of the loan together with interest charges and any other charges, are secured by a mortgage over the property. The maximum amount that can be drawn against the equity of the property is determined by the provider according to market conditions, taking into account the property's value and the age of the applicants.

The reverse mortgage is repayable on the owner's sale of the property or death. Research shows that reverse mortgages make up nearly 97% of the home equity market in New Zealand.1 This paper primarily focuses on these schemes. It is also useful to be aware of the other types of HEC schemes that are available.

Home Reversions

These types of schemes involve the sale of the property in return for a capital sum or supplementary income. The sale is generally for a reduced price with the borrower having continued rights of occupancy.

Reversion schemes have only recently been available in New Zealand, but overseas they take a variety of forms around the sale of all, or part of the property.

Shared Appreciation Schemes

These are a form of home reversion under which borrowers draw on some of the property's equity and lenders rely on the appreciation of the property's equity on its eventual sale.

Other schemes with some similarities to HEC schemes

The concepts behind HEC schemes are not limited to private companies. The Government has a residential care loan scheme whereby the Government advances loans to meet residential care fees to rest-home residents who do not qualify for subsidies, and secures those loans by taking caveats over the home.

The concept of assistance recoverable on sale also applied to advances offered for essential repairs and maintenance of homes by the Social Security Department for many years. For a period of time Housing New Zealand Corporation offered deferred payment loans to older people to repair or improve their homes. More recently, some local authorities are accumulating and deferring rates liabilities and interest charges with repayment claimed on sale of the house or the death of the owner. Local authorities’ interest rates are about 3-4% below HEC rates.

The owners of some retirement villages can make HEC-type arrangements with new residents. These are usually unsecured, and are repaid when the borrower’s occupation rights agreement with the owners is terminated.

The benefits of HEC schemes

A significant number of people commencing retirement do so with modest supplementary income or savings over and above their New Zealand Superannuation. The value of supplementary income or savings generally diminishes over the 16-18 years of an average retirement. The resources available to older people to meet essential commitments to improve their quality of life, or to exercise their life choices, can gradually reduce as they age.

Using home equity to raise cash can enable older people to enjoy an improved quality of life, to keep their homes maintained, to meet medical expenses, to assist family members, or to enjoy extras such as holidays. The release of equity can also be used to relieve the burden of debt repayments for mortgages, credit cards and personal loans. There are also wider benefits to the economy when older people are able to make choices about how they use their financial resources. Being able to use some of the equity tied up in a property gives older people the flexibility to meet costs that cannot be met from their regular income.

The emphasis on home ownership

Home ownership has historically been a favoured means of saving among working New Zealanders. Older people tend to have significant financial investment in their homes. About 75% of older New Zealanders own their own home, the great majority without mortgage debt. In the 65 to 69 age group, 80% live in their own home. Of those aged 85 or more, 55% still live in their own homes.²

Research suggests that 70% of net wealth in New Zealand is invested in housing. New Zealanders have just 22% of their net household wealth in financial assets such as shares, bonds and cash. Citizens of the United States have 65% in such financial assets, United Kingdom households 55%, and Canadian and Swedish households 46%. New Zealanders’ traditional preference for investing in residential property means that the potential use of HEC schemes is high.³

There is a large potential for growth in HEC schemes

New Zealand private home equity is worth nearly $170 billion, but HEC advances in New Zealand were around $100 million in 2005. The current New Zealand market is regarded as relatively immature with only a few providers offering HEC loans, and the great majority of these loans being made by only one provider.

HEC schemes have had a limited take-up in New Zealand. Based on information provided to researchers by two of the main product providers, it appears that there had been a take-up of approximately 4,000 loans by September 2006.

Setting standards will stimulate interest in the HEC market from both consumers and providers, as well as promoting competition. Greater competition may lead to the availability of a wider range and type of products to suit consumers’ needs, as well as potentially forcing down prices.

Older New Zealanders are commonly wary of getting into debt. Most have spent many years paying off their mortgages to be free from financial worries in their retirement. The effect of compounding interest on HEC loans is a significant deterrent. Compound interest is interest that is paid on both the principal amount and on the accrued interest. Simple interest is payable only on the principal amount, the interest is not compounded. This, together with a general suspicion of such products, may have contributed to older New Zealanders slow take up of HEC loans.

Note: Compound interest is paid on both the principal amount and on the accrued interest. Simple interest is payable only on the principal amount, the interest is not compounded.

Alternatives to HEC schemes

There are a range of alternatives to HEC loans that can be considered by older people that can release capital from their homes. The Retirement Commission’s “Sorted” website, www.sorted.org.nz, offers information about four alternatives to HEC schemes. They are, renting part of the house, subdividing the property, downsizing to a smaller property at a lower cost, or selling the home to family or whanau. If home owners intend to leave their home to their children, the children may be willing to provide their parents with financial assistance in the knowledge that they will eventually inherit the property.

Protection for borrowers

A risk, which may need to be taken into consideration by older people, is if self-interested family members put pressure on their parents to take up a HEC scheme and then use the money for purposes which are contrary to the best interests of the parents. There may also be a risk if family members discourage older people from taking up such schemes for self-interested purposes.

The rights and interests of older people are an important consideration in the development of products such as “home equity conversion” schemes, because without protections for older people’s financial interests, it is unlikely that an effective market for these products can be developed. An effective financial market not only needs a good supply of products, but it also needs potential consumers who are well-informed about the quality and price of products on offer and the merits of alternative suppliers.

Independent consumer education programme

Not all the issues that are raised in relation to protections for HEC loan borrowers call for standards. Some might be best addressed through specific wording; for example, in the Disclosure Statement. Other issues might be addressed through the processes to be observed by legal advisers, financial intermediaries, or through consumer education.

As HEC schemes are relatively new to the New Zealand market, there may be a need for an independent consumer education programme on the benefits and risks of HEC loans. Better education for consumers will also exert pressure on providers to design better and more suitable products.

Existing consumer protection

HEC schemes are already subject to consumer protection law. For example, the Fair Trading Act 1986 requires that any information given to a consumer by a HEC provider must not be misleading or deceptive. The Consumer Guarantees Act 1993 requires that goods and services be fit for the purpose.

In addition, the Credit Contracts and Consumer Finance Act (CCCFA) 2003 will also apply to most HEC products. For example, a reverse mortgage is a credit contract, and a home reversion is a buy-back transaction. The Credit Contracts and Consumer Finance Act 2003 sets out requirements in respect of disclosure, prohibiting unreasonable fees, prohibiting oppressive conduct, allowing changes in case of unforeseen hardship, and cancellation rights. In the case of buy-back transactions, the Credit Contracts and Consumers Finance Act 2003 requires that consumers obtain independent legal advice before entering into the agreement.

An issue to consider is whether the existing consumer protection law provides sufficient protection for consumers who purchase HEC products, or whether additional protections are required.

The need to create minimum standards in an enforceable code

International experience has shown enforcement of appropriate standards and controls of complicated HEC schemes protects consumers and their families. HEC loans involve legally and socially complex issues and are likely to become increasingly significant as New Zealand’s population ages. Potentially, it affects many New Zealanders of all ages, since the use of home equity by older people impacts on the inheritance available to their families.

In the United Kingdom, reversion schemes that involve complex forward selling of property were not included in the regulatory regime; they were treated as property sales. These schemes have recently been included in the United Kingdom HEC regulatory framework.

The wider financial context

There are a range of consumer protections arising from existing legislation, such as the Credit Contracts and Consumer Finance Act 2003, the Fair Trading Act 1986, and standards setting bodies such as the Advertising Standards Authority. The experience that has been gained from establishing and enforcing standards in other types of financial products needs to be applied to HEC schemes.

The Ministry of Economic Development and the Ministry of Consumer Affairs are leading a number of reviews that can be expected to impact on the overall financial environment within which HEC schemes are offered.

• A broad based review of financial products and providers that aims to establish an effective and consistent framework for the regulation of non-bank financial institutions, financial intermediaries and financial products.
• A review of financial intermediaries such as brokers, financial planners and others who advise people on saving options and financial products.
• A review of industry-led regulation released by the Ministry of Consumer Affairs to assist industry, consumers and government to develop, operate and evaluate such forms of self-regulation as voluntary codes of conduct and consumer disputes resolution machinery.
• A review of the enforcement of consumer protection law.

The Office for Senior Citizens will work closely with the Ministry of Economic Development and the Ministry of Consumer Affairs during this consultation phase and will ensure HEC recommendations are linked to the outcomes of the reviews mentioned above.

Conclusion

In the United States, United Kingdom and Australia there has been an increasing interest in and use of HEC schemes by older people. In New Zealand the take-up of such schemes is still relatively modest, but greater use of the equity tied up in homes is likely. The Office for Senior Citizens is seeking a range of views on how best to regulate this market and protect consumers.