Reverse mortgage explained

What is a reverse mortgage?

A reverse mortgage is a product that allows you to draw on your home equity to take out a loan. Reverse mortgages are designed to use the value you have in your home to get a cash boost, regular income stream or line of credit while you remain in the property and enjoy its ongoing capital growth. Generally speaking, reverse mortgages are designed for homeowners aged 60 and above, and they can be used for a variety of reasons, ranging from funding retirement to living expenses, renovations, a holiday or medical bills.

How does a reverse mortgage work?

A reverse mortgage allows you to borrow money based on your home equity—in simple terms, home equity is the difference between the value of your home and any money you have owing on it. If the value of your home is $900,000, and you own it outright with no mortgage owing, then you would have $900,000 in equity.

That said, a reverse mortgage will not allow you to borrow the entire value of your home equity. This means that even if you have $900,000 in equity, you won’t be able to take out a reverse mortgage for this much. Instead, you will be able to borrow a percentage, which starts at 15%-20% and increases each year from age 60 onwards, up to a maximum of 35%.

A reverse mortgage is different from a standard home loan, in that you will not be required to make regular repayments on it—typically you will be required to repay your reverse mortgage when you vacate your property. Associated interest and fees will also be payable.

How much can I borrow with a reverse mortgage?

How much you can borrow with a reverse mortgage depends on how old you are and the value of your home. The Australian Government’s Moneysmart website says if you’re aged 60 then the most you can likely borrow is between 15% and 20% of the value of your home. As a guide, you can add 1% for each year over 60. So, at 65, the most you could borrow will be about 20–25%. The minimum amount you can borrow can vary, but is generally around $10,000.

You can use Moneysmart’s reverse mortgage calculator to get an estimate of how much you may be able to borrow, and how much you’d need to repay.

You can usually take the loan as a lump sum, regular payment or line of credit, or even a combination of the three. Unlike a regular mortgage—such as the one you probably took out to buy your home in the first place—you don’t need to make regular repayments on a reverse mortgage. Instead you pay off the loan if you sell your home or move out, or if you die and the home becomes part of your deceased estate.

But you need to be aware that the amount you owe on the loan will grow over time as interest compounds on the outstanding value. You may be able to make voluntary repayments to help reduce that outstanding amount. It’s important to note that not all lenders offer a reverse mortgage so you may have to shop around to find one that suits. The Australian Government offers their own reverse mortgages in the form of the Home Equity Access Scheme, which may offer more competitive interest rates than commercial lenders.

Who is eligible for a reverse mortgage?

Eligibility for reverse mortgages usually require that you be:

• An Australian homeowner

• Over the age of 60, including the youngest borrower if you are borrowing as a couple

Some lenders may also have differing minimum ages, minimum property value requirements and specific post codes that are eligible. Properties such as primary residences, holiday homes and investment properties may be considered as a security for a reverse mortgage.

What should I consider before taking out a reverse mortgage?

Before you take on a reverse mortgage you should check to see what impact it may have on your finances.

For example, Moneysmart says any home equity release scheme could affect your eligibility for the Australian government’s Age Pension. The impact that the money from a reverse mortgage can have on an Age Pension will depend on how it is used.

If it is taken as a lump sum and spent on an asset, such as shares, a car or property, and it is then assessed by Centrelink as part of the Age Pension’s asset test, it may reduce or make you ineligible for the Age Pension altogether. If the lump sum builds up in a savings account, it could also potentially count towards the asset test. There may be assets like necessary home renovations, which may be exempt from this test.

Other things to consider, according to Moneysmart, are whether any reverse mortgage payments could affect your ability to pay aged care costs, future living expenses, medical bills and home maintenance. It would also reduce the value of your estate when you pass away, as the loan would have to be paid out of any money you hope to pass on as inheritance.

You might want to consider getting some independent professional financial advice to see what impact any reverse mortgage payments would have on your finances.

How can you use a reverse mortgage?

A reverse mortgage could be used in the following ways, unless the lender specifies otherwise:

• Buying a new car

• Helping your children or grandchildren buy their first home

• Modifying or renovating your home to ensure it can facilitate your retirement

• Covering unexpected medical bills

• Creating a regular income stream, be it fortnightly or monthly

• Refinancing an existing mortgage

• In-home care expenses or transitional costs when moving to residential aged care

What are the benefits of a reverse mortgage?

As with any credit product, you should look at the potential benefits and drawbacks of a reverse mortgage to see if it suits your needs. Reverse mortgages are generally used for home owners who have more assets than disposable cash or savings.

For example, if you needed money for medical purposes and you didn’t have the available savings on hand, then a reverse mortgage could be an option to consider.

A reverse mortgage can also improve your long-term retirement funding, as it enables you to access the value from the equity of your home without needing to sell it. This could mean you wouldn’t need to downsize or move due to financial pressures.

What are the potential benefits of a reverse mortgage?

• If you’re in a difficult spot financially or have cash flow problems due to not working, a reverse mortgage could help relieve stress in the form of a lump sum of cash or regular income.

• A reverse mortgage could allow you to enjoy your retirement a little more, such as by going on more holidays.

• It could help you pay for any urgent care services or medical expenses without the need to repay the money immediately.

• You could use a reverse mortgage to establish a contingency or emergency fund, which can give you some peace of mind if something unfortunate or costly occurs.

What are the potential drawbacks of a reverse mortgage?

• Interest and fees are still payable on a reverse mortgage, and the interest rate you’re charged is likely to be higher than on a standard home loan.

• Interest on a reverse mortgage is compounded and the loan size increases over time, reducing equity if you plan to sell your home.

• If your property doesn’t rise in value while interest is compounding, you may be left with minimal equity when it’s time to sell.

How do you repay a reverse mortgage?

Generally, your reverse mortgage is repaid from the future sale of your home, such as if you were to downsize or move into residential aged care. If you stay in your home until you pass away, the loan will be paid from the proceeds of your estate. Your estate will typically have 12 months in which to repay the loan. You can also repay the loan at any time without penalty or the need for a redraw facility.

How do reverse mortgages differ from home equity loans or lines of credit?

Banks and other financial institutions also offer home equity loans and lines of credit which can allow homeowners to access the equity they have built up in their homes. However, these credit products may be difficult to access for retirees as they require regular loan repayments, as well as borrowers to have a steady income.

This can be especially difficult if interest rates increase, causing the repayments to increase in turn. This could potentially erode your retirement income or savings over time. If you are unable to make the repayments, your home may be repossessed by the lender and sold to pay the remaining debt. This risk of losing your home is removed with a reverse mortgage, due to the negative equity protection that comes with these types of mortgages.

Can you lose your home with a reverse mortgage?

No, as reverse mortgages are regulated by the Australian Government’s National Consumer Credit Protection Act 2009, in particular its 2012 ‘no negative equity guarantee’ clause. Moneysmart says reverse mortgages that were taken out from 18 September 2012 have this negative equity protection. That means the amount that ends up being owed to a lender cannot exceed what the home is worth (either in market value or equity) and protects you as the borrower under law.

Lenders must also make reasonable inquiries into your financial situation, before offering you a reverse mortgage or other loan product, under Australia’s responsible lending laws. They do so by assessing your credit score, income and expenses to find out if the reverse mortgage would be suitable for your needs.

It can be a good idea to talk to an independent financial adviser before making any decision on a reverse mortgage. Checking what fees and charges may apply can also be important. These can often be found in the Product Disclosure Statement (PDS), Target Market Determination (TMD) and other relevant documentation.

Additional reporting by Nick Whiting

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