By Janine Starks*
From my mailbag:
We are a couple in our 80s with good health, but our car is ancient and dilapidated. We need to replace it, but we are cash-poor and asset-rich. We get along perfectly well on our pension and don’t need any more income. We have $45,000 set aside for expenses such as dentures, glasses, hearing aides and two funerals. Should we buy a new car from our savings or prise the $25,000 cost from the house, with a loan repaid from our estate?
It’s wonderful to hear the engines are humming and all pistons are firing inside those 80 year old bodies. Apart from the minor servicing needs of ears, eyes and teeth, you seem very lucky on the health front and managing nicely on your pension.
The old bomb in the garage may have reached its use-by date, but you can’t let that curtail the fun of the best years of your life.
Putting aside the lotto ticket solution, here’s a list of options to weigh up:
1. Attack your savings
You have savings, but a good chunk has to pay for two funerals (around $18,000) and with good health you could easily be around in 10 years. While $45,000 sounds like a decent amount, it reduces to $27,000 net of funerals. That’s easy to chew through with extras, maintenance and appliances blowing up. So you risk getting in a pickle if you use this money to replace the car – to suggest otherwise, would be irresponsible. But before jumping straight into bed with a Reverse Equity Loan, you could consider some more inventive alternatives.
2. Savings now, loan later
You could consider using your savings to buy the car and take out a loan in a few years time (when the remaining cash reserves are running low). Given the interest rates are higher than a mortgage, these loans can inflict some damage on your families inheritance. The advantage is to delay the higher interest charges. The disadvantage is that in a few years time, taking out a loan might seem too stressful or confusing with age. If the pot runs dry and family have to step in, you’ll feel helpless.
If you choose this path, think about discussing the issues now with your children and solicitor, with consideration given to a Power of Attorney to deal with a loan if it seems too much to handle. It might feel uncomfortable, but my guess is your children will have the utmost respect for your ability to think ahead.
3. Family front up for free
Instead of borrowing from a financial institution, consider whether your children would prefer to help. It might feel awkward, but being transparent can be quite liberating. At the end of the day your home is most likely to be split between them (less amounts going friends or charities).
The alternative is to say nothing and imagine your children sitting in your lawyer’s office being told Mum and Dad took out a Reverse Equity Loan 15 years ago. Technically they should have no issue with it – you don’t need anyone’s permission, and it’s most rude for any child to pre-calculate an inheritance. But think of the child who sits there with a lump in their throat, wishing they could have purchased the car and made it easy for you.
All you have to do is raise the idea of a Reverse Equity Loan and its pros and cons. That gives ample opportunity for any offer to come forward and it also leaves children completely aware that the value of the house is not going to remain intact, eliminating any surprises.
4. Family earn interest
Another more innovative idea is to offer family the opportunity of earning interest themselves. Rather than pay an institution, one child might like to keep the profits in the family. It’s wise to inform other family members of the arrangement as the no-surprise attitude keeps everyone happy. Other children need to be clear it was not a gift. Wills can be adjusted to protect the child making the loan, to ensure it’s repaid with interest, prior to the remaining value of the home being split between them. You must see a solicitor for advice.
5.Reverse Equity Mortgage
If you borrow the $25,000 lump-sum (using the house as security), interest clocks up, but nothing is repaid until the house is sold on your death (sometimes called ‘Equity Release’ loans). While they attract criticism in some quarters, without these loans thousands of retirees would be trapped without access to money. Where they pinch, is when young borrowers (e.g. in their 60s), withdraw large amounts. If they survive 25 or 30 years, the eventual loan repayment can destroy much of the value in their home. On the flip-side, those who are older, and borrow small sums, find the effects of compound interest far more manageable and it might be offset by house price rises.
A number of providers exist with a few examples being Sentinel currently charging 6.7 percent interest, SBS Bank at 7.1 percent and ASB at 7.25 percent. The rates are roughly 1 to 1.5 percent higher than a standard variable mortgage.
As an example, a $25,000 Sentinel Lifetime loan:
· Costs $1,200 to set-up, $125 for top-ups and $395 to release
· Interest compounds at 6.7% (long-term average 8.95%)
· After 10 years the loan value will be $51,000 (6.7 percent) or $64,000 (8.95 percent)
· After 20 years it increases to $100,000 (6.7 percent) or $156,000 (8.95 percent). Surviving that long, makes for an expensive car.
· A $350,000 house would increase to $426,000 in 10 years with 2 percent house price inflation each year ($76,000 gain)
As can be seen, a $76,000 capital gain on your home over 10 years would offset the $50-60,000 loan repayment from your estate. But never bank on it – I’ve held property that didn’t increase a cent over 7-8 year periods. Any asset can stagnate or fall in value.
Even if gains do offset the loan, inflation will eat into the value of your children’s inheritance. While I feel obliged to point that out, I’d also question why anyone would feel guilty about it. Any child expecting you to curtail your lifestyle to provide them with an inflation proofed inheritance is a grownup brat.
You can read about all the pros and cons at www.sorted.org.nz and Consumer have a 2009 report which is available for $10. Sentinel has a calculator on their website and you plug in the amounts you might borrow and see what the repayment would look like from your estate. Good luck with your decision and enjoy those new wheels.
Email questions to email@example.com, subject line: Financial Agony Aunt. Anonymity is guaranteed.
*Janine Starks is Co-Managing Director of Liontamer Investments. Opinions in this column represent her personal views and are not made on behalf of Liontamer. These opinions are general in nature and are not a recommendation, opinion or guidance to any individuals in relation to acquiring or disposing of a financial product. Readers should not rely on these opinions and should always seek specific independent financial advice appropriate to their own individual circumstances.