Trusts / Asset Planning
It is common for those in retirement years to find themselves asset rich but cash poor. This problem is highlighted when the unexpected large bill arrives and funds must be found. There are a number of options available for accessing funds but each must be considered in light of the particular circumstances.
For example, a couple, Mr and Mrs Brown, have been married for 50 years, and have three adult children. They are living in their own home which has a value of $550,000 and is mortgage free. They have just discovered they have to repair the roof which will cost $30,000. They have no cash reserves to fund this repair. What can they do?
A. Approach their children for a loan. This can be formally recorded in a deed, with the loan to be repaid on the death of both of them or the sale of the property. This provides certainty for Mr and Mrs Brown but the children's investment does not "grow" and, typically, does not pay interest.
B. The children purchase a share in the house. This provides cash for the couple, plus also enables the purchasing children to share in any potential capital growth, or loss.
C. Sell the property and either buy a smaller property or rent.
D. Take out a term loan from a bank with the interest "capitalised". This means borrowing the $30,000 plus an additional amount to pay all interest for a calculated period of time. The couple draws down $30,000 for the roof repairs and the remainder is retained to cover the interest. For a loan period of 10 years the total amount to be borrowed would be approximately $50,000 and the monthly interest amounts to approximately $160 at current rates.
E. Take out what is called a reverse equity mortgage from a specialist provider of this kind of product. This enables someone over 60 to use the equity in their home to borrow against. No repayments are required. The interest compounds. The loan is repayable upon the death of the survivor of the couple. This provides real certainty for the couple but can leave little or nothing of the value of the house for the children. The loan is capped at the value of the property. There are high entry fees for some of these loans, plus solicitor's fees, valuations etc. In addition the interest rate is higher than the standard bank housing loan rate.
If Mr and Mrs Brown borrowed $30,000 from such a provider, in 10 years time the amount owing will be $63,951. In 20 years that $30,000 loan will have grown to $131,101. There is no guarantee that property values will increase to ensure any equity is retained in the house.
For options D and E in particular, the children, on the death of both of their parents, may receive a lesser inheritance.
However, let us change the scenario to what is now becoming a very common situation. Mrs Brown has died after 50 years of marriage, and under her will she has left everything to Mr Brown. Mr Brown has married June, a widow, with three children from her previous marriage.
June and Mr Brown are living in Mr Brown's house. June and Mr Brown have entered into a contracting out agreement, providing that the house is Mr Brown's only. What are the consequences of each of the options now? What will Mr Brown's children inherit on June's death?
A. A loan from Mr Brown's children
Mr Brown dies, under his will June has a life interest in the house. The loan, realistically, will not be repaid until June's death. Mr Brown's children may not be happy with this, but ultimately they will get the value of the house.
B. The children purchase a share in the house
Again, although the inheritance may be delayed, Mr Brown's children will ultimately get the share of the house owned by Mr Brown's estate.
C. Sale/rent
Again, the children's inheritance will essentially remain intact, being either the smaller house or the remaining cash proceeds.
D. Term Loan
The term loan may continue beyond Mr Brown's death. But there is a fixed term. The loan must be repaid at the end of 10 years unless renegotiated. The house may need to be sold and either a smaller house purchased or the sale proceeds invested and the income made available to June through her lifetime. The children's inheritance may be smaller but the "loss" will have been fixed prior to their father's death.
E. Reverse Equity Mortgage
Under a reverse equity mortgage the estate can be rapidly depleted. June and Mr Brown may both be the borrowers. The loan will continue on after Mr Brown's death. If the balance of the loan at Mr Brown's death was, say, $63,951 and if June lives for another 10 years the loan balance will, using current prevailing interest rate of 7.2%, increase to $131,101. Mr Brown's children may not be happy with this result.
Many over 60s are asset rich but cash poor. For many their home is their only asset available to fund their lifestyle. The options set out above are regularly being considered by families. All families are different, and the ideal options involving funding from within the family may not be available to many families. We recommend that if the only options are to borrow from outside sources, careful consideration should be given to the family dynamics now and going into the future, and to continue estate planning which takes any funding arrangements into account.
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The contents of this publication are general in nature and are not intended to serve as a substitute for legal advice on a specific matter. In the absence of such advice no responsibility is accepted by Brookfields for reliance on any of the information provided in this publication.
