The problem with HER schemes, says Morgan, is that they can chew through the owner’s capital quickly and if the owner changes their mind, or they face a large unexpected costs (say a medical bill) there is not much room to move.
He also criticised the set-up costs of such schemes, citing 4% of the house value (an average of $12,000) as common.
“These mortgages are available for people as young as 60. Given life expectancy is well over 80 for 60 year olds, that is a lot of years not to change your mind during!” says Morgan.
HER provider Sentinel argues that few people are taking out HER schemes that young in any case – the average age is 73 - and that the maximum cost is “less than $2000”.
A structural difficulty identified by Morgan is that New Zealand does not really have a long term debt securities market, and that means lenders such as Sentinel have to raise funds on the short term market.
That more unstable interest rate exposure means lenders charge a risk premium, Morgan says, which means the HER market is more expensive than its counterparts in the UK or US.
“It looks like currently the interest rate charged is 10%, some 3% above the first mortgage floating rate. And of course should floating rates rise, so will it.”
That is not so, says Sentinel’s actuary, Chris Coon. The current rate is 8.95% - 1.2% above the standard variable mortgage rate, and not 3 percent above.
HER schemes will always be more expensive than standard mortgages, he says, because of the loan repayment guarantee, which allows the borrower to either pay back the accumulated debt or the house realisation price, whichever is the lower.
“Thus there are no further calls on other assets, as with a standard mortgage. The securitization of this debt is more complex and thus more expensive.” In the US, the loan repayment guarantee gets paid to a government agency, and is the equivalent of 2% of the house value plus 0.5% of the accumulated debt.
“The Loan Repayment Guarantee risk is a hard risk to find reinsurers to cover. I am aware of a number of companies in the UK that have sought this cover, and as far as I know, Sentinel is the first company in the world to develop and place a robust form of reinsurance to cover this risk.”
HER interest rates are typically about 1.5-2.0% higher than standard mortgages, and he believes competition will keep the rate towards the lower end of that scale, he says.
As for the concerns about borrowers “chewing” though the capital too early, Coon says the schemes are set up based historical patterns of house prices, and interest rates. Typically, the equity does not start to decline for the borrower until after they turn 90.
“Gareth’s “chewing” up remaining equity clearly does not apply unless interest rates v. house value appreciation breaks away from past patterns. Of course this can happen, and that is why reinsurers charge as they do for the guarantee cover.”
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