Legal Tip 407: Informal ‘Reverse Mortgages’ from Adult Children and Estate Planning

Older people sometimes are asset rich and income poor and they are reluctant to sell to raise funds as this can affect the pension. So, they sometimes enter into a reverse mortgage with high interest rates and inflexible terms. This will give them some cash, but the equity in the house might slowly be eaten up by interest accruing. This as an indirect affect on the persons that will eventually inherit this house.

There may be an alternative and this is for the inheritors, often the adult children, to help fund the house owner, often the parent to help them avoid needing to enter into a reverse mortgage.


Example

Grandpa Simpson is in his 70s. He is asset rich but cash flow poor. He wants to get his hands on some money without having to sell his house, but because he has no income he cannot borrow.

Luckily, he has a son, Homer, who is willing to help out. Homer worries that if Grandpa sells the house and spends the money, he will have nothing to inherit. Grandpa would also loose the pension if he sold too as his assets would be above the threshold for Centrelink pensions.

Homer therefore agrees to start paying his dad a ‘pension’. He lends his dad $20,000 per year to supplement his government pension. This won’t affect the government pension of his old man as is it is not income under the social security act or taxation acts.

Grandpa gets to enjoy himself more with this extra money boosting his spending power.

Homer thinks he is losing out because he is paying interest on the money lent, but he realises that Grandpa’s house is growing in value at about $50,000 per year so the longer he delays selling it the more Homer will inherit – assuming Homer doesn’t die before his dad. This will also be tax free for Homer.

If Homer dies first since it is a loan to his dad it is a debt that can pass via Homer’s will. Grandpa might now owe Marge the money. Even if Grandpa changes his will at this point Marge will be able to recover the amount borrowed by Grandpa.

Such a loan might also help if Grandpa gets a lover and there is a family law claim. He has been hanging around an 80 year old stripper called Doris so you never know.

 

Reverse mortgages through official channels have protections incorporated where private arrangements may not. However there is also a alternative to reverse mortgages which can erode equity in a diffferent way which is called a home equity release. Its a sell down of the property which gives a lender a % share of the sale later in exchange for funds being advanced today. This also may include protections to limit what that % is if values fall. However, a private reverse mortgage can be used to advance use of the property equity without trigger of CGT issues but is then a debt.

eg Dad is thinking of selling his home to assist rising living costs and buy a car etc. His sole beneficiary is his daughter Samantha. Samantha is fully supportive of Dad needing more $$ as he cant get a traditional bank loan and is happy to lend to dad this year and future years to avoid the high costs of a reverse mortgage or a sell down of equity (home equity release) or a complete sale. Samatha advances funds to her Father under a properly documented loan which is assisted by a local soliictor. . In return she realises it means that Dad may die in his own home and she understands that the main residence exemption simplifies taxes through that avenue. Dad likes this as it means he isnt paying the high costs to a lender and he keeps his own home. Samantha also is wise and realises if she places a caveat over Dads home it may limit his occassional housekeeper Esmerelda from seeking to exploit him if his mind gets foggy with age later.