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Mary’s Q&A column appears in the Business section of the Weekend Herald. Mary was a finalist for the "Best Columnist – General" award for this column in the 2014 Canon Media Awards.

NZ Herald March 3 2007

Seeking your questions about KiwiSaver
Q&As: Are home equity release (HER) schemes - which lend to retired people with homes but little income - a rip-off?
Sentinel defends its HER schemes, but they are still expensive compared with possible alternatives.

Seeking your questions about KiwiSaver

The government's retirement savings scheme, KiwiSaver, comes into effect on July 1. Practically everyone who starts a new job will be automatically enrolled in the scheme, although they can opt out after two to eight weeks if they wish. Every other New Zealand resident aged 18 to 65 will also be eligible to sign up.

In the lead-up to KiwiSaver, the Herald plans to run some special sections to help readers make key decisions about their involvement in the scheme.

The sections will include readers' questions, with answers from Mary Holm. Please submit your questions for consideration (maximum 200 words) by March 7, to mary@maryholm.com or Money Column, Business Herald, PO Box 32, Auckland.

Some basic facts about KiwiSaver:

Participants will contribute either 4 per cent or 8 per cent of their income. A key attraction will be a kick start from the government of $1,000 for everyone who remains enrolled for at least a year. After a year's enrolment, you can take contribution holidays, or continue to contribute.

Your money will be invested in a private sector provider's savings fund. You can choose the fund or let the government allocate you to a fund. The government will subsidise investment fees.

Generally, your money will be tied up until you turn 65, but there are exceptions: You can withdraw money if you suffer hardship or serious illness, if you emigrate permanently, or if you are buying a first home and are eligible (the eligibility rules are yet to be announced). The government will also contribute towards the purchase of your first home - $3,000 if you have been in KiwiSaver for three years, ranging up to $5,000 if you have been in for five years. (A couple can get up to $10.000). If you die, the money goes to your estate.

Some employers may boost their employees' contributions to KiwiSaver, and if they do that, no tax will be payable on the employer contributions.

Question: In a recent column you wrote, "It's also true that the current home equity release schemes charge pretty high interest."

It would be more honest to say that the current schemes are nothing more that a high class rip off to be avoided at any cost.

What about compounding interest monthly for starters. And a $40,000 loan going to $160,000+ in under 14 years.

The crux of the matter is many older people find their incomes are not adequate for their desired standard of living.

These are the naive, culpable, greedy or just plain stupid who, in letting their wants exceed their needs, are ensuring the proliferation of these rip off schemes.

Anybody can make their own choices in life. But "there is a sucker born every minute", and these reverse mortgages and like schemes are there to very efficiently exploit them.

Who knows whether or not the government isn't pushing this type of financial package with the long-term view of reducing social spending?

Answer: Since when did a government take a long-term view on anything? Let's skip the conspiracy theories and concentrate on whether home equity release (HER) loans are rip-offs.

For the benefit of others, HERs are typically used by retired people who have mortgage-free homes but too little cash.

They borrow money against the equity in their homes. Usually, they make no regular repayments, so the interest compounds until the loan is repaid when the house is sold - perhaps when the borrower moves to a retirement home, or when they die.

You're quite right to say that a $40,000 loan can turn into more than $160,000 in less than 14 years.

Using the Rule of 72, divide the interest rate into 72 and you get the number of years it takes for a loan to double.

At 10 per cent, the loan will double in about seven years. It will double again in 14 years. The current interest rate charged by Sentinel, the biggest HER provider, is 10.5 per cent, so the growth will be a little faster than that.

That is indeed rapid. And it's something everyone pondering a HER should be aware of.

But that doesn't make it a rip-off. Savers are happy to watch their account balances grow as interest compounds. The same goes for HER providers. If they receive no repayments until the end of the loan, they can expect the interest to compound in the meantime.

Here's another way to look at it: With an ordinary mortgage, we often end up repaying twice or three times what we borrowed, and that's despite making regular repayments. Without such repayments, we must expect to repay even more.

Note, too, that the value of the house will probably be growing at the same time.

Let's say that your house is worth $300,000. And, as above, over 14 years your $40,000 HER loan grows by $120,000, to $160,000.

Even if your home value grows at only 3 per cent a year, it will be worth an extra $150,000 in 14 years - more than making up for the loan growth.

While the house grows at a slower rate, the growth is on a larger amount.

What about the monthly compounding of interest? Even some critics of HERs say that is to be expected. Most mortgage accounts are settled monthly. Still, it's another point for people to be aware of.

Where are we, then? It doesn't seem to me that HERs are rip-offs. But are they are a good idea? See the next Q&A.

Question: As always we read with interest your Saturday column partly looking for reference to our product area and partly because they provide insights to what is really happening in NZ homes.

The reference recently to HER being "expensive" is a perception we continue to battle in this new sector as New Zealanders continue to compare standard floating mortgage rates with our and other HER interest rates.

Currently Sentinel's variable rate at 10.5 per cent is only 1 per cent higher than the main banks' floating mortgage rates, and we provide a product that has no repayments plus a loan repayment guarantee. These two costs alone substantially eat into any rate differential, as follows:

With interest normally added to the loan rather than paid, and therefore no predictable cash flow, this adds around 0.5 per cent to our cost of funds compared with a normal mortgage.

The loan repayment guarantee ensures that whatever happens the borrower will never be asked to repay more than the net sale proceeds of the home. We reserve for and reassure a proportion of this risk. Per the recent UK Institute of Actuaries report on HER this cost is estimated at 0.8 per cent a year. Really the product should not be sold without this.

So, the difference is not a reflection of inflated margin but of our genuine additional costs.

I think part of the reason HER is viewed as expensive is the compounding effect. Whilst non-repayment is a key attraction of the product we do allow borrowers to repay interest or principal at any time without penalty.

Perhaps a little more focus should go on what the funds are being used for. This includes maintaining the home (preserving their most valuable asset), and repaying credit card debt. These decisions are easy to justify economically as the cost of the loan is less than the cost of not doing it.

The decision to improve quality of life is perhaps harder to justify economically. How do you value a cataract operation that enables you to see, or helping loved ones?

Clearly there may be other potential sources of funds. If the family have spare funds, that's great, but that is mostly not the case.

Downsizing may also be feasible, but most want to continue to live in the same area and often this will free up little capital, when buying, selling and moving costs are taken into account - notwithstanding the emotional stress.

If it is the only way to make a difference, and the client believes it is worth doing, how is this expensive?

Signed: Vaughan Underwood, managing director, Sentinel

Answer: Thanks for explaining your interest rates. Apparently you are not necessarily making exorbitant profits - just covering higher costs.

That doesn't mean, however, that HERs are inexpensive. For a start, the majority of New Zealand mortgages are on fixed rates, which are considerably lower than floating. Some mortgage lenders also charge lower fees than HERs.

If a retired person can obtain an interest-only fixed-rate mortgage, it will be considerably cheaper than a HER. They will, of course, have to make interest payments. But on a $30,000 loan at 8 per cent, those would amount to $200 a month, which some could afford.

A bank might even accept partial interest over the years and the rest on sale of the house. It's worth asking. I hear, too, that some building societies and credit unions offer variations on HERs at cheaper rates.

Another possibility: While, as you say, many families don't have "spare funds", family members are often saving for their retirement. It might be possible to borrow from their savings, on the promise that it would be repaid when the house is sold.

Interest could be set at, say, 8 per cent, which is a good risk-free return to the family member. And there would be more house left for them and other family members to inherit than if their parents take a HER loan.

On your point about why people take out HERs, it's quite true that using a HER loan for home maintenance or repaying credit card debt will usually be better than letting the home deteriorate or continuing to pay 20 per cent interest on a credit card bill.

And, as you say, what price do you put on health or family relationships?

People take out HERs for some pretty good reasons. They are not necessarily "naive, culpable, greedy or just plain stupid", as our correspondent above thinks.

Again, though, while funding these expenses with HERs might be a good move, using other funding sources might be even better.

* Mary Holm is a seminar presenter, author and publisher. Her website is www.maryholm.com. Her advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following it. Send questions to mary@maryholm.com or Money Column, Business Herald, PO Box 32, Auckland. Letters should not exceed 200 words. We won't publish your name. Please provide a (preferably daytime) phone number. Sorry, but Mary cannot answer all questions, correspond directly with readers, or give financial advice.

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