What is a reverse mortgage

What is a reverse mortgage?

Reverse mortgages allow you to borrow against your home equity. They’re generally designed for older homeowners who have partially or entirely paid off their mortgage and want to free up some extra cash. 

Unlike a normal home loan, you only have to pay back a reverse mortgage when you sell or move out of your property. 

And you don’t necessarily have to occupy the home in order to take out a reverse mortgage – you can usually access equity in either your home or an investment property.

How does a reverse mortgage work?

A reverse mortgage is a loan secured against the equity in your property.

Your lender approves you for a loan of up to a certain amount, which you can usually receive as a lump sum, regular smaller payments, a line of credit, or a combination of the three. You don’t have to pay any of it back until you sell the property, but you’ll be accruing interest on whatever you borrow, and this can compound.

To illustrate how this could work, imagine you borrow a lump sum of $30,000 at 9% p.a. to pay for a holiday. According to MoneySmart, when you sell your home five years later, nearly $47,000 (assuming interest compounds monthly) would be deducted from the sale price to repay the reverse mortgage. That’s $30,000, plus five years of interest at 9% p.a., which equals nearly $17,000.

If you can, it’s a good idea to make voluntary repayments beforehand to reduce your eventual bill. Some lenders may even allow you to pay the entire loan back early without break costs, but others might not, so it’s important to check beforehand.

If you pass away with an outstanding reverse mortgage, the debt has to be paid from your estate, typically within six to12 months.

What to know about reverse mortgages in Australia

In Australia, reverse mortgages are typically reserved for homeowners aged 60 and over. Many major banks no longer offer them (Commonwealth Bank, for example, discontinued its Equity Unlock Loan in 2019) but several lenders still do.

In 2012, the Australian Government introduced a ‘no negative equity guarantee’ that applies to reverse mortgage products. That means you can never owe more than what the property is worth, even if the outstanding balance is higher. That’s partly why lenders now cap reverse mortgages at a fraction of the property’s value.

The Australian Government also offers the Home Equity Access Scheme to Aussies of Age Pension age or above, which works like a reverse mortgage. While it’s only available if you’re eligible for a pension, it tends to offer rates significantly lower than those on reverse mortgages.

How much can I borrow with a reverse mortgage?

According to MoneySmart, if you’re 60 years old, the most you can borrow is typically 15% to 20% of the value of your home, and this goes up by another 1% for each year you’re aged over 60. If you’re 70, for example, you might be able to access up to 25% to 30% of your home’s value. The minimum loan amount is generally around $10,000.

You can use MoneySmart’s reverse mortgage calculator to estimate how much you can borrow and what you’d need to repay.

Pros and cons of reverse mortgages

Benefits of a reverse mortgage

There are a few reasons why a person might take out a reverse mortgage, like:

• If you’re ‘asset-rich, cash-poor’, a reverse mortgage can unlock liquidity without you having to sell your property.
• Since you don’t have to pay the loan back until you sell your property, taking out a reverse mortgage likely won’t dampen your cashflow.
• Reverse mortgages can help fund practical ageing-related expenses, like home improvements or care that could help you live at home for longer.
• Lenders will usually allow you to use funds from a reverse mortgage however you want. That means you could forget about being sensible and go on an expensive holiday or buy a jet ski (though, you should be aware of the long-term financial impacts before doing so).

Drawbacks of a reverse mortgage

As with any credit product, you should take a minute to work out whether a reverse mortgage is the best option for you. There are a few downsides to taking out a reverse mortgage:

• Interest rates on reverse mortgages tend to be higher than those on normal home loans.
• While you don’t have to make ongoing repayments, your debt will still be accruing interest for however long it’s outstanding. This could mean you end up paying more overall than if you were making regular repayments.
• If you get unlucky and your property loses value, or if you simply hold the reverse mortgage for a long time, you could end up losing a huge chunk of any proceeds when the time comes to sell, even with the ‘no negative equity guarantee’ in place.
• If you take out a reverse mortgage and put the money into certain assets like shares or even a savings account, it could affect your Age Pension eligibility.

Are there alternatives to reverse mortgages?

There are a few other ways you might be able to access the equity in your property without a reverse mortgage.

You could refinance or ‘top up’ your home loan

You may be able to borrow against your home equity by refinancing your mortgage or taking out a new home loan. 

Standard home loan rates are generally lower than reverse mortgage rates, so you could save money on interest this way. 

However, you’ll likely need to make regular repayments, which could eat into your retirement income or savings. You’ll also run the risk of having the property repossessed if you can’t pay, which can’t happen with a reverse mortgage because of the ‘no negative equity guarantee’.

You might consider home sale proceeds sharing

Home sale proceeds sharing or home reversion is an arrangement where you sell a portion of the future value of your home to an investor (‘provider’). Say you sell a 10% share in your property—you’ll receive a lump sum now and, when you sell, the investor receives their share of the proceeds. 

Home reversions aren’t loans, so you won’t pay interest, but investors normally pay a discounted price for their portion of the property, which means you’ll receive less than what the share is worth. If your property value flies upwards, you’ll also potentially lose out on lots more money than you would have with a reverse mortgage (while your provider is laughing).

Or look into the Home Equity Access Scheme

If you’re eligible for a pension, you could use the Home Equity Access Scheme instead of a reverse mortgage. You’ll need to have adequate insurance (for at least 90% of the value of the property) and meet other eligibility requirements, but if you qualify,this could be a significantly less expensive way to access your equity.