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LPLC: Crystal-ball gazing

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Cite as: (2007) 81(12) LIJ, p. 90


Equity-release products are complex and have many variable terms.

Reverse mortgages and other equity-release products are now widely available to Australian consumers. Beyond the usual risks of certifying mortgage transactions, these products pose additional challenges for lawyers.

Cash-poor retirees are attracted to the notion of access to cash with no capital outlay. Borrowers often approach lawyers, having already decided in principle to sign on for an equity-release product. There is often a broker or a salesperson pitching the product to the client and adding pressure to sign the client.

The lawyer’s first task may be to dispel the client’s assumption that the borrowing is a good idea, or even the best available option. This point can only be reached by exploring the reasons why the client wants the money, considering other possible forms of borrowing and assessing the ultimate costs and risks.

What extra risks?

These products are more complex and have more variable terms than standard mortgage products. Recommend that clients obtain independent financial advice before any legal advice is dispensed. Lawyers need to take time to understand the fine print in the contract and the ultimate effect on the borrower’s security. It may take a number of hours to take instructions, become familiar with the contract and consider it in light of the client’s circumstances.

There are many hidden traps in equity-release products which need to be teased out, for example, understanding when title passes from the borrower.

In some home reversion schemes, for example, the borrower becomes only a life tenant. In that situation, at the very least, a caveat must be lodged to protect the life tenant’s position against subsequent dealings with title.

Default provisions

Borrowers may resort to equity-release products because they can’t service a conventional loan, with potentially catastrophic consequences if the default provisions are exercised. The lender may be able to call up the loan early, apply a higher rate of interest or even force the sale of the property. So it is crucially important that lawyers understand and explain the default provisions fully to the client.

Imagine a client Edith, a 70-year-old widow, wants to draw on $40,000 of the equity in her home in order to live in Queensland for six months to spend time with her daughter and grandchildren. A close reading of the contract might reveal that a default is triggered if the property is vacated for any length of time and so the product is wholly inappropriate for Edith’s purposes. Many equity-release products require borrowers to maintain continuous building insurance and upkeep of the property, and Edith’s extended vacation could trigger a default on these grounds.

Duress

Equity-release transactions provide the opportunity for asset-rich retirees to be exploited by others for this ready source of cash. What if the client Edith was borrowing $40,000 against her home to lend to her 25-year-old gardener? She might need to be counselled against her decision, particularly where the loan is for the benefit of a third party or intended as a gift.

Any objective indications of pressure or influence would require the lawyer to:

  • take extra precautions to ensure the client understands the risks; or
  • refuse to act if the client appears to be acting under duress.

King Lear’s daughters?

What if the client Edith comes in to the office with one of her adult daughters, who is seeking to tap into the equity in the family home.

At this point the lawyer needs to see Edith alone, discern whether there are any indications of pressure or vulnerability and provide independent advice.

Consider the family dynamics, what the money is for and the possible benefit of having a round-table discussion with the immediate family. What if the money is for loan to one daughter and other family members stand to lose a share of the ultimate estate?

Without well-documented instructions and advice, this is the kind of moment that could launch future litigation.

Remember, if the family members and heirs can support an alternative form of borrowing, this is likely to cost less to the borrower’s estate than a reverse mortgage.

Some situations should immediately raise the risk management flag and require the lawyer to decline to act. For example, if Edith’s daughter, acting under a power of attorney, came into the office wanting to access an equity-release product and the borrowing offered no apparent benefit to Edith as donor.

Crystal-ball gazing

Equity-release products involve an inevitable measure of uncertainty about the size of the ultimate debt. Some of the important variables to consider are: the loan amount and rate of interest, the value of the mortgaged property over time and the borrower’s life expectancy.

If lawyers take the trouble to calculate the compound interest that would accrue on say five or 10 or 20 years borrowing, the sums might shock the client into considering an alternative.

Charge an appropriate fee for your advice. Providing advice on an equity-release product takes time and judgment.

Document your advice and record the client’s response, then confirm your advice to the client in writing.

Consult the Legal Practitioners’ Liability Committee checklist for advice on equity-release products at http://www.lplc.com.au for more information and be very clear that you are providing legal not financial advice.


This column is provided by the LEGAL PRACTITIONERS’ LIABILITY COMMITTEE. For further information ph 9670 2001 or visit the website http://www.lplc.com.au.

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