Funding retirement: analysing Shared Appreciation Mortgages

According to the Association of Superannuation Funds of Australia (ASFA), retirees need to access around 70% of their pre-retirement income in order to live comfortably. Unfortunately, most Australians are not achieving this figure, and are falling 40% below this benchmark on average. 

For the average Australian, this shortfall is not due to a lack of wealth, but is instead due to a lack of liquid cash flow. The home of the average retiree is worth $1.1 million, around 40% greater than the median price for houses in state and territory capitals around the country. This disparity between assets and liquid funds is leading Australians to look elsewhere as they seek to fund their retirement.

In the first article in this series, we examined annuities — looking at the advantages and disadvantages of utilising these instruments as a retirement vehicle. In this piece, we’ll be putting another retirement funding method under the microscope: shared appreciation mortgages.

Understanding Shared Appreciation Mortgages

A shared appreciation mortgage (SAM) is a way of borrowing money for a property purchase that benefits both the borrower and the lender once the property is sold. Under the terms of a SAM, the borrower will pay a pre-agreed portion of the home’s appreciated value when they come to sell the property. The borrower will still keep most of the resale value of their property but will essentially pay interest on the appreciation of the property directly to the lender. Both the borrower and the lender are “sharing” in the appreciation of the property’s value.

This makes a SAM different to a standard mortgage. With a standard mortgage, the borrower simply needs to pay off the principal amount, plus any charges, fees and interest accrued over the duration of the mortgage. If the principal has been paid off in full, the borrower will keep any profits relating to an increase in the property’s value for themselves. If the principal has not yet been paid off in full, the sale proceeds can be used to pay off the outstanding balance.

The advantages of Shared Appreciation Mortgages for retirees

Shared appreciation mortgages are not savings accounts or annuities and do not provide ongoing funds for individuals of working or retirement age. However, they can significantly reduce month-to-month expenses, which can have a positive impact on available funds at retirement.

This is because lenders are typically willing to provide a SAM at a far lower interest rate than a standard mortgage. Depending on the amount borrowed, homebuyers may be able to complete their transaction with no monthly repayments, as the lending institution will receive the full principal amount — plus a portion of the appreciated value — once the property is sold.

In other cases — such as when a property buyer took out a mortgage with a high loan-to-value ratio (LVR) — the borrower may have to make some monthly repayments, but these are likely to be far lower than they would be with a standard mortgage. Both instances result in reduced monthly outgoings and improved cash flow for the borrower. 

As we have touched on above, the problem for the average retiree is not lack of asset wealth but lack of liquid cash. Thus, reducing monthly outgoings can provide a substantial advantage to retirees as they seek to secure a comfortable standard of living. Despite this, take-up for shared appreciation mortgages remains very low, so why aren’t more Australians using this method to fund their retirement?

The disadvantages of Shared Appreciation Mortgages for retirees

Unfortunately, there can be major disadvantages for Australians who take out a shared appreciation mortgage, particularly as these individuals approach retirement.

  • Borrowers are not reducing their principal

If the borrower is not making monthly repayments, they are not reducing the principal on the mortgage. While the borrower may not be paying much interest on their loan — or any interest at all — this still means they are carrying a high level of debt into their retirement years. This debt will need to be paid off when the property is sold, plus the pre-defined additional payment.

  • Property prices can depreciate

There is no guarantee that property prices will continue to appreciate in the future. If the property were to fall below the initial purchase value, this could leave the borrower in a difficult situation.

  • Retirees can essentially become trapped in their homes

Retirees may find that they cannot afford to sell their property if they hold a SAM. A standard mortgage will allow the borrower to keep the funds they receive from the sale, minus the principal and any additional charges and fees. With a SAM, the borrower will need to pay all of the principal, plus the agreed portion of the value appreciation, when they sell the house. As a result, it may become difficult to purchase a new property, leaving the borrower with limited options.

Providing alternatives to Shared Appreciation Mortgages

These disadvantages listed above make SAM products unsuitable for most Australian retirees. While monthly outgoings are eased, the long-term debt burden makes this a risky option. In fact, a SAM can leave Australians with limited control over their finances in retirement.

Here at Futureproof, we want to make life easier for retirees, giving them a better option for managing their finances even after they have finished working. This is why we are developing the Equity Preservation Mortgage (EPM) — a new, low-risk-weighted and responsible alternative to instruments such as SAM products or other funding options.

In Australia, 76% of retirees are homeowners, with an average home wealth of $1,100,000. While this is lower than the USA’s rate of 80% homeownership, the average home wealth is almost double that of American retirees, who own assets worth around A$542,000 on average. Australia’s retirees are similarly better off than their British counterparts — in the UK, only 74% of retirees are homeowners, and their average home wealth is only A$887,000.

This makes it imperative that Australian retirees can access a tax-free equity income with no depletion of home equity. Futureproof’s Equity Preservation Mortgage™  is designed with this in mind.

Reach out to the Futureproof team to discover more about the EPM, and please join us again for the next article in this series, where we will be examining guaranteed income investment products