How to use Equity Release Mortgages to plan your retirement

Balcony of a big white house

What is an equity release mortgage?

An equity release mortgage (ERM) is not for everyone but, used properly, it can give significant freedom and quality of life to many people who own property and are on a limited income such as government superannuation. ERMs allow you to borrow against the value of your property with no need to make repayments. The interest is added to the mortgage balance and the mortgage is repaid when you vacate the property. A lifetime guarantee means you can stay in your home for the rest of your life, and a ‘no negative equity guarantee’ prevents the mortgage ever being more than the value of your home. With an equity release mortgage you always own your own home.

Planning your retirement

Over half of all people who reach the age of 65 make it to the age of 85. So when it comes to your retirement savings, the difficult question is: how long do you need to budget for your savings to last? The lack of an annuity market in New Zealand gives retirees few options. It also means that people tend to plan conservatively due to a fear of running out of money, and their risk-averse choices impact on their quality of life. Take, for instance, a retired couple with a $500,000 house and $300,000 of savings. We have budgeted on spending $50,000 per year after tax (which affords them $25,000 of holidays/purchases and $25,000 of living expenses.) Of this $32,000 needs to come from savings. The $300,000 lasts them 12 years (now aged 77.) By then the house is worth $620,000 (in real terms.) If at 77 we now switch to drawing the $32,000 per year from the house then by 85 the couple still has $433,000 of wealth. At 90 we have reduced the spend to $20,000 per year and by 100 there is still close to $300,000 of equity remaining. In contrast, if we ignore the house and budget to spend the $300,000 over 25 years, the couple will be able to spend $36,000 per year ($14,000 less.) Of course our retirees could spend $50,000 per year and at the age of 77 decide to sell down their house, get something small and cheaper, and extract equity this way. Both options have pluses and minuses. If they selling their property, the couple will incur both sale and buying costs, and they will pay tax on any earnings from investing the freed-up capital. So talk to your adviser and lender about an equity release mortgage and find out if this could be the right option for you.