Reverse mortgages: What you need to know

Almost every home owner knows what a mortgage is. After all very few of us have the funds to buy a new home sitting in our bank account, so inevitably we all figuratively trot cap in hand down to the local bank to borrow the money we need, and get that wonderful financial burden called a mortgage.

One of the great benefits of a mortgage is the forced savings it enforces on is. Over time we all pay down that mortgage, creating wealth in the ownership of our own home. One of the great issues however has been how to access this wealth which then becomes effectively trapped in that same home.

For retirees this is particular frustrating, as they often own a very valuable asset but have very limited income, as of course your home does not generate any income when you are living in it. So many are forced to sell that home to access the equity they have built up.

So what if there was a way to access all that equity without having to sell your home and move? Welcome to reverse mortgages!

A reverse mortgage is a loan that allows you to borrow against the equity of your home. They offer a way to tap that equity in your own home and access it without having to sell.

Usually used by seniors, these loans are not understood very well. In 2018, the Australian Securities and Investments Commission reviewed reverse-mortgage lending and found borrowers had a poor understanding of the risks and costs of reverse mortgages and how they could affect their ability to afford their lifestyle needs.

So to help our readers navigate the world of reverse mortgages, we’ve put together everything you need to know about reverse mortgages, how they work, and whether they’re right for you.

What is a reverse mortgage?

A reverse mortgage is a type of home loan that is specifically designed for pensioners and retirees who are typically ‘asset rich’ but ‘cash poor’. Also known as senior’s loan and senior’s finance, reverse mortgage is the most popular form of home equity release in Australia. Reverse mortgages allow people to borrow against the equity in their home, freeing up cash to allow them to pay for medical bills, travel, loan money to their children, buy an investment property — you get the idea.

How does a reverse mortgage work?

Let’s say you’ve paid your house off, and you’re expecting to retire in a couple of years. However, you’ve recently decided that you want to help your daughter get into the property market earlier by loaning her $15,000 to make up the rest of the money she needs for the deposit.

To fund this, you’re looking at that house you’ve paid off. You could sell it and buy somewhere cheaper, giving the money you make to your daughter, but you really like the area you’re in. With this in mind, you decide to use your home as security to release $15,000 in a reverse mortgage. This way, you don’t have to sell your home, and you can help your daughter out.

As with standard home loans, a reverse mortgage is secured by the first registered mortgage over the borrower’s house. The amount of equity that can be released is generally determined by age and the value of the security property — and on your repayment history. Although interest is charged as with any other loans, you do not have to make repayments while you live in your house – the interest compounds over time and is added to your loan balance. You remain the owner of your house and can stay in it for as long as you want to. You will only have to repay the loan in full (including interest and fees) when you sell your house, move to an aged care home or die. But you can usually make voluntary payments if you wish.

Most people will take the money as a lump sum, but some choose to receive regular pay outs or access a credit line. The latter two options are less popular because they eat away at the equity however.

Reverse mortgages may be an alternative if other finance options are not an option due to the property owner’s income situation.

If you’re 60, most banks will let you borrow between 15% and 20% of your equity. The general rule of thumb is that every year over 60 is 1% more you can borrow. At 70, some people may be eligible to borrow as much as 25 or 30 per cent of the equity in the property.

We can hear what you’re thinking — this sounds like a great deal. You can borrow money and then not have to pay it back? Why isn’t everyone doing this?

Should I take out a reverse mortgage?

Before you run to the bank to take out a reverse mortgage, you should have a good, long think about what it will do to your bottom line. The loans (as all loans do) carry a degree of financial and legal risks attached.

The major issue with reverse mortgages is that the interest rates can be higher than the normal payable rate on a standard mortgage. This adds up quickly, meaning you could have far more to pay back than expected, potentially putting a lot of strain on you in the future. The other major problem people run into surrounds ownership of a house when there is a living spouse. If a couple lives in the home but only one person owns the house, the surviving spouse might not be able to live in the home after the owner’s death, particularly if the house needs to be sold to repay the loan.

Reverse mortgages can also affect pension eligibility.

If you are taking out a reserve mortgage, it’s a good idea to estimate the long-term costs, including set-up fees and compound interest. Review estate plans, if there are any, particularly if there is one person who is intended to inherit the home.

As always, we recommend getting independent financial and legal advice before you decide to take out a reverse mortgage.

Written: 14 January 2020

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