This article was published on 5 October 2019. Some information may be out of date.

QRe your answer to a recent letter, I wondered if I could add a note of caution.

A family member took a reverse mortgage on their home to do home improvements. I don’t think they were aware of how quickly the debt would grow, as you pointed out.

They believed their house would increase in value to compensate, but due to serious health issues they had to sell their large home on a slow market. Once the loan was repaid they did not have enough money to buy even a small place.

The good news was another family member was looking to buy a rental property and knew they would be ideal tenants. They pay a reasonable rental, and retain a nest egg from their sale.

ABut still, they lost their home. Thanks for warning others.

Reverse mortgages can be tricky — particularly if you get one early in your retirement.

With one of these loans, you don’t make any repayments over the years, but repay the loan in full when you leave the home. In the meantime, the interest compounds, so the loan balance grows. That’s the opposite to a normal mortgage, with a declining balance. Hence the “reverse” name.

If you retire with a mortgage-free home, a reverse mortgage can be a good way to turn some of the money tied up in your home into cash. But it’s important to understand how these loans work.

A calculator on the website of Heartland Bank, the only big financial institution currently offering reverse mortgages, is useful here.

Let’s say your house is worth $600,000, and the lender charges 6.95 per cent — the current Heartland rate. This is higher than on other mortgages, because the loans are riskier for the bank and are more expensive to run.

The maximum you’re allowed to borrow increases as you get older, because there’s less time for compounding interest to grow.

  • At 65, you can borrow up to $120,000. When you’re 75 the loan will have doubled, and at 85 it will be around $480,000. At 95, it will total $960,000, but that’s not as scary as it seems.

The calculator tells us that, if we assume house prices grow by 3 per cent a year, your house will be worth more than $1.4 million by then.

But what if house prices don’t rise as fast — as happened to our correspondent’s relative? Let’s say they increase by 2 per cent a year. At 95, your house would be worth a little more than $1 million, not a lot more than the $960,000 loan. That’s uncomfortable.

Heartland does provide a “no negative equity guarantee”, which means the loan repayment “will never exceed the net sale proceeds of the property”. So you wouldn’t end up owing more than you get for your house when you move out. But still, if house prices rise slowly you could end up with little equity in your home.

  • At 85, you can borrow up to $240,000. When you’re 95 that will have doubled to $480,000, but if house prices have grown by 3 per cent, your home will be worth more than $800,000. Even if prices rise by only 2 per cent, it will be worth $730,000 — still way ahead of your loan.

The message: reverse mortgages are like gardens that aren’t well cared for. Over a relatively short period the plant growth is fine. But over a long period the growth can get out of hand.

It’s a good idea, therefore, to avoid a reverse mortgage when you first retire. Instead, plan to spend your savings until you reach, say, 80 or 85. Then, if you don’t find NZ Super is enough — many people find it’s sufficient at that stage — get a reverse mortgage.

Even then, though, borrow only as much as you need in the short term, with the idea of adding to the loan as you go. That keeps the compounding interest under control. If you want the loan for daily spending, you will probably be able to set up a regular payment into your bank account.

Of course there’s no way of knowing what sort of reverse mortgages will be available in the decades ahead. But in the past there has always been at least one lender offering them, and I would be surprised if that doesn’t continue. Whenever you borrow, always look out for that “no negative equity guarantee”.

QI’m the accountant with a focus on tax who occasionally writes in. I read your column every week. Just wanted to make a comment on the person who said in your last column: “You said last week that mortgage interest on rental properties is tax deductible. Has not the government scrapped this from 1st April this year?”

You replied that he’s incorrect, that mortgage interest is still deductible.

But I think he was talking about the fact that as from 1 April 2019, losses on residential rental properties are “ring-fenced” and thus cannot be claimed against other income (such as PAYE wages). They have to be carried forward to use against future rental property income. (There’s a whole suite of rules around this, of course, but that is basically the story.)

Just as an aside: this was an initiative of the Labour government. Andrew Little, who championed this rule, said in 2017 that very few “Mum and Dad” rental property investors use losses from residential rental properties against their income. This is completely contrary to my own extensive experience in this area.

AI bet you’re right, that the correspondent was thinking of the ring-fencing of losses.

Your last comment is interesting, that many rental investors are affected by the change. Whether that’s good or bad depends on your perspective. Perhaps landlords should be glad they got away with just ring-fencing, rather than a capital gains tax. But let’s not reopen that door!

QJust commenting on the person who thought interest wasn’t deductible on rentals since 1 April. Two quick points:

  • They’re probably referring to ring-fencing of rental losses, which began on this date.
  • You mentioned you can’t imagine the removal of deductibility of interest for rentals. It would indeed be a heinous bastardization of our tax code — but then, so is the ring-fencing of only rental losses, and they did that.

I don’t think most legislators care much about tax system integrity. Further to that, the UK (a tax system largely similar to ours, though a bit more complex) only a few years ago took steps towards exactly this. Rental interest is no longer deductible there. Though you do get a bit of tax relief, it’s less than half what it should be.

AInteresting about the UK. It seems nothing is sacred when it comes to tax.

If our tax system had true integrity, mortgage interest should actually be deductible for everyone with a mortgage, not just landlords — given that all the interest we receive is taxable. A mortgage interest deduction is allowed in the Netherlands, Switzerland and the US, according to Wikipedia.

Also, what about indexing tax brackets, so that we’re not taxed more when our income rises just to keep pace with inflation? Without indexing, we can’t buy any more with our money, but we pay more tax. Not fair.

The list could go on. Unfortunately, every tax system ends up being compromised for political reasons. I suppose it’s one of the prices of living in a democracy.

QSmall loan, big loan, cost $40. Neutral. Apples vs apples?

Maths is a tool. Percentages have been misused this time.

ANot really. You’re referring to last week’s lead Q&A, which noted that a $40 admin fee is added to most student loans each year if the account balance is $20 or more.

The correspondent said the fee makes a big difference to him, because his loan is small. His original loan was $370, but it grew to $570 because of the fee before he realised.

Paying $40 on the original $370 was a charge of more than 10 per cent. And paying $40 on $570 is still a high charge, at about 7 per cent. So he will now repay the loan.

However, he pointed out that for his partner, with a $25,000 loan, the $40 makes little difference. It’s better for her not to repay her loan faster than she has to, as it’s interest-free as long as she stays in New Zealand.

You say $40 is $40. That’s one way to look at it. But you’re ignoring what else the man and his partner could do with their money.

Let’s say they have savings they could use to repay their loans.

  • The man could earn a tiny bit of interest on his $570 — say $11.40 at 2 per cent a year. If the loan is growing by the $40 a year fee, he’s going backwards. He should pay off the loan.
  • But his partner could earn lots of interest on her $25,000. At 2 per cent it would come to $500 a year, far exceeding the $40 fee. Even if she hasn’t got that much money sitting around — let’s say she has $5000 — that would still earn her $100 a year. She’s better off to build up her savings than repay her loan.

The pedants might say that the man’s $11.40 a year will grow with compounding interest. But it would take many years for that to get ahead of the $40 annual fee.

QI write in response to your Q&A re the couple in their early 60s who are planning to leave Auckland and retire in the Coromandel, and wondering whether they would be able to return if they changed their minds in a few years.

We have a suggestion for them, which we discovered by accident. A few years ago we sold our Auckland property and moved to Waihi. I was still working in Auckland, so we bought a one-bedroom apartment in the city centre near my workplace, and enjoy the freedom to be either in the city or Waihi.

The “by chance” thing was that the apartment is in a hotel building. That has given us some additional flexibility for the future which most apartment owners would not have.

When I do retire, we will be able to place the apartment in the hotel pool (for a minimum of a year), and get some income from it. After that, we could use it ourselves again if we wish, without having to go through a buy/sell process.

Or we could rent it out for a few months at a time if we wanted to manage it ourselves, keeping special periods when we would want to be in the city free for ourselves.

An additional advantage is that maintenance is covered by the hotel management under the body corporate fee, and the apartment is secure. Obviously the rental return would not be as high for us, but we think the flexibility compensates for that.

This could be an option for your correspondents, who are not keen to be landlords themselves. As long as they choose a good property, their apartment value will stay in line with the market, and if they find that they don’t plan to return they can sell at that time.

You may be aware of issues concerning this that we are not yet aware of, in which case we would be interested to know of them!

AA good suggestion. Thanks. I don’t know of any problems with this set-up, but let’s hear if any readers do.

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Mary Holm is a freelance journalist, a director of Financial Services Complaints Ltd (FSCL), a seminar presenter and a bestselling author on personal finance. From 2011 to 2019 she was a founding director of the Financial Markets Authority. Her opinions are personal, and do not reflect the position of any organisation in which she holds office. Mary’s 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 [email protected] or click here. Letters should not exceed 200 words. We won’t publish your name. Please provide a (preferably daytime) phone number. Unfortunately, Mary cannot answer all questions, correspond directly with readers, or give financial advice.