Getting ripped off – and how regulation can help bring it about

The Age carried stories on the weekend of the collapse of a company called “Money for living”. It preyed on elderly people who were asset rich(ish) and cash poor by buying their home (often worth around a third of a million dollars in return for a paltry lump sum of around $50,000 plus an annuity of very poor value.

Money for Living was run by a criminal who had defrauded others and been to jail for three years and was acting outside the law in being a director of Money for Living. The company didn’t exactly defraud the oldies it duped. But it was unable to fund itself without on-selling the houses and of course this undermined the security of the oldies tenure in their homes and their annuities. It was a kind of Ponzi scheme, although you’d think that the terms on which the houses were purchased were sufficiently advantageous for the entrepreneur that it wouldn’t need to be a Ponzi scheme.

Be that as it may, Money for Living has now run out of cash and for the oldies who it duped, it’s become money for nothing. They may even lose their homes. It used advertisements featuring Dawn Fraser and Paul Cronin which can’t make them feel too good now. I guess their agents should have checked the credentials of the company a bit better.

Though this is an unusually nasty case, and these outrages may have been perpetrated in any event, it is an example of the sharp practices that thrive in an environment in which we try to outlaw things that we find uncomfortable.

Current affairs telly has always thrived on events like evictions. And there’s always the cry that ‘something should be done’ to prevent it. And one of the things that unsettles us is the idea of people being thrown out of their homes, and even more oldies being thrown out of their homes.

So we’ve regulated to keep these images off our television screens as much as we can. The Uniform Consumer Credit Code requires that lenders assess the capacity of their borrowers to service the loans they provide them and not provide credit where serviceability cannot be demonstrated.

Sounds fair enough doesn’t it? But it isn’t.

The regulation ensured that my cost of credit was unnecessarily high when I left my job and set up a business despite quite good equity and twenty odd years of paying my bills. My problems are not a big deal, though they are of some interest given that encouraging entrepreneurialism and innovation is one of the new motherhood objectives of contemporary policy.

But pity the poor asset rich and cash poor oldies. Nothing says they can’t sell up and move to more down-market digs and spend the difference. But the UCCC says they can’t borrow against their own homes. Why? Because, they don’t have the income to ‘afford’ it even if they have the equity.

A new type of financial instrument has stepped into the breach. At considerable cost some of the more entrepreneurial lenders like Advance Bank did the ‘government relations’ legwork to set up the reverse mortgage.

But, to address our finer sensibilities and ensure we’ve not allowed people access to products that could see them evicted, however sound of mind and body they are, reverse mortgages are a lot more expensive than normal mortgages, and less flexible.

Often one cannot borrow more than 20% of the value of the home in the first instance and they have substantially higher interest rates. That’s because reverse mortgages come with the guarantee that you won’t be turfed out of your house. Sounds nice of course, but it costs as people are unable to extract as much equity as they otherwise would be able to and pay about 1 or more percent per year extra in interest to fund the insurance products that deliver on the implicit life interest ceded the borrower.

All fine and dandy of course. But not if you know quite well that you only want to live say another five years in your house before moving. Or if you’re of sound mind and you decide that the best option for you is to run down your equity and then decide what to do in the knowledge perhaps that there’s equity elsewhere, or that you only need a small share of the equity you will have when you’re sold up. Lots of the homes of the elderly in Sydney will go for a couple of million leaving plenty for a move down-market.

Note that the UCCC provides ‘safety valves’. Solicitors funds are exempt. So solicitors can make money lending at outrageous rates exempt from the UCCC. Solicitors wouldn’t do anything nasty now would they? That’s one of the reasons why so many scams involve solicitors funds.

These kinds of restrictions on credit are also the feeding ground for a practice called ‘wrapping’. Here a house is ‘rented’ to the tenant for 20 odd years at way over the odds for the rental price after which time the house is theirs. In effect the repayments, plus a hefty margin become the rent. This is all fair enough in theory and I have spoken to lots of ‘wrappers’ who are doing very well for themselves, and seem like thoroughly nice, ethical people. But the implicit interest rates charged to tenants are around 9% and often more. Why can they charge this? Because the people they help are poor savers. Wrapping provides a service to them because they need no deposit. They have poor savings habits.

So wrappers are their last port of call. Lenders are prohibited from lending more than some vaguely specified idea of what they can afford. The (arbitrary) industry practice is usually that people can’t afford more than 30% of their income in rent. So if you lent more than this it might be unenforceable.

Problem is, if they fail to meet their payments, they can be turfed out of their houses without accruing any of the equity that a borrower in a standard arrangement would have. There should probably be some regulatory arrangement addressing this issue. But we’re too busy banning things that we shouldn’t be banning. And eventually when the political spotlight turns to wrapping, it won’t be a large industry, and anyway, it’ll just be a few unidentified poor people we’re doing out of options to get on in their lives (no doubt existing wrapping contracts will be ‘grandfathered’).

So maybe well just ban it.

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