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Information on Reverse Mortgages

What is a reverse mortgage?

A reverse mortgage is a type of loan that allows you to borrow money based on the equity you have in your home. It is generally only available to people aged 60 and over, and is often considered to be a loan for those who are ‘asset rich’ but ‘cash poor’, meaning that a large portion of their wealth may be tied up in assets rather than in available cash.

How does a reverse mortgage work?

A reverse mortgage works by allowing a borrower to use the equity they have in their home in order to take out a loan. The key difference between a reverse mortgage and a standard one is that instead of the borrower making payments to the lender, as they would with a standard home loan, the lender instead makes payments to the borrower. In return, the lender receives equity in the property.

A reverse mortgage can be paid out as a lump sum or as a recurring payment at regular intervals, with the latter option commonly being aimed at retirees who are looking to boost their income. It can also function as a line of credit, which allows a borrower to draw on their equity, up to an approved limit.

With a line of credit loan, interest only starts to accumulate once you withdraw money, but it is worth keeping in mind that this type of loan tends to have higher interest rates than a standard loan. A line of credit loan will typically have monthly fees attached, and depending on your lender, these may be charged whether the line of credit is being used or not. Given that interest is usually charged at a variable rather than fixed rate, the amount of interest charged can be often more difficult to accurately forecast.

What is equity?

The term ‘equity’ refers to the difference between the current market value of a property and the amount left to pay off on the mortgage. Say, for example, that the market value of your home is $800,000, and you have $200,000 left to pay off – this would mean that you have $600,000 in equity. If you have owned a house for a long time, then it is possible that the value may have increased since you bought it. This means your equity in the house will also have increased.

How much can you borrow with a reverse mortgage?

The amount that you can borrow with a reverse mortgage will depend on the amount of equity you have in your home, although generally you will only be able to borrow a certain percentage of this equity. If you make regular principal and interest repayments and the value of your property increases over time, this percentage will become higher as you get older. So it might be the case that if you are 70, you might be able to borrow a greater percentage of your home’s value than if you are 60. The decision as to how much you can borrow will ultimately come down to your individual lender, though.

What does a reverse mortgage cost?

There are three costs to be taken into account with a reverse mortgage – initial establishment fees (which can include such things as application and processing fees), ongoing fees, and interest rates. These will depend on your individual provider. Over time, your equity will decrease and your debt will grow, according to Moneysmart.

With interest rates, the comparison rate of a loan refers to the total annual cost of a loan, taking into account the interest rate as well as upfront and ongoing fees and charges, and you can find out more about comparison rates with Canstar.

Do you retain ownership of your home with a reverse mortgage?

With a reverse mortgage, you retain ownership of your home and can remain in it for as long as you want, as long as you don’t default by breaching obligations (which could lead to the bank forcing a sale of your home). It is worth keeping in mind that the equity you have in your home will decrease the more you borrow on it, and your debt will increase.

When do you have to pay back a reverse mortgage?

Unlike a standard mortgage, which is generally paid back at regular intervals, the balance of a reverse mortgage is payable when the borrower dies, moves away from the home permanently or chooses to sell it. At this point, the balance of the loan must be paid back, along with any interest that has accrued over the lifetime of the loan.

You will still be able to leave your home to your heirs in your will, but the balance of the loan will need to be paid back. If the house is sold for more than the amount that is owed to the lender, then any money left over will go to your estate.

What are some things to be wary of with a reverse mortgage?

If you are considering a reverse mortgage, you may want to check fees and charges, consider compound interest and think about any potential impact on the age pension.

Fees and charges

The fees and charges associated with reverse mortgages can be higher than those attached to regular mortgages. It is possible you might be charged establishment fees, ongoing or annual fees, or discharge fees, and these will likely be included in the amount owing on the mortgage, meaning you will pay extra interest over time.

Compound interest

One of the main things to be wary of with a reverse mortgage is compound interest. Although interest is charged on a reverse mortgage, you will not need to repay it while you are living in the home, and as mentioned earlier, the loan only needs to be repaid when you sell the home, move away or die.

This means that, when the principal owing on a traditional mortgage decreases over time as it is paid off, the amount owing on a reverse mortgage increases, and this amount can increase over time. It is important to be aware of this before taking out a reverse mortgage, as you or your estate could potentially be left with very little equity.

Potential to affect age pension

While taking out a reverse mortgage does not make you ineligible for the age pension, it can nonetheless have an impact on your eligibility for payments from Centrelink. For information on how this could affect you based on your particular needs and circumstances, you can contact Services Australia’s Financial Information Service.

What are some other features of reverse mortgages?

Other features of reverse mortgages include flexibility of repayments and negative equity protection.

Flexibility of repayments

When you take out a reverse mortgage, the full amount of the loan must be paid back at the conclusion of the loan, along with accrued interest. Though you are not required to make repayments on a reverse mortgage while you are still living in your home, you are generally free to do this if you wish, without incurring a penalty, as you might with other types of home loan such as a fixed rate loan.

Negative equity protection

Negative equity describes a situation where the market value of your property is lower than the balance remaining on your home loan. In Australia, there are statutory protections in place to ensure that a borrower who holds a reverse mortgage is protected from negative equity, so the amount of money owing to the lender will never be more than the market value of the home.

What is the Pension Loans Scheme?

The Pension Loans Scheme (PLS) is an Australian Government initiative that helps pensioners and self-funded retirees receive an income boost. It is a voluntary reverse equity mortgage scheme that allows Australians to receive a non-taxable supplement secured by the value of their homes. It works in the same way as a typical reverse mortgage, with compound  interest, and the loan can be repaid in increments at any time or in full when the property is sold. Further information is available on the Services Australia website.

Before taking out a reverse mortgage, it is important to understand the impact it will have on your financial future and your retirement. It is also important to keep in mind that if you pass away with money owing on a reverse mortgage, the balance of the money owing will need to be paid off to settle the loan. According to Moneysmart, reverse mortgages taken out in recent years in Australia have negative equity protection, so the amount that ends up being owed to a lender cannot exceed more than a home is worth (either in market value or equity).

What is home reversion?

Home reversion is a scheme that allows you to sell a portion of the future value of home and continue living there. It is an alternative option to a reverse mortgage, but it comes with its own particular set of risks.

A home reversion provider will buy a portion of the value of your home at a discounted rate, and you will get a lump sum in cash. Later, if you opt to sell the home, you will have to pay your provider back their full share of the proceeds.

Say, for example, your home is worth $600,000. A 20% share in that home would be worth $120,000, but a home reversion provider may purchase that share for a discounted price – for example, $80,000.

Later, when you sell your house, you would pay the home reversion provider 20% of the total sale price. This would mean that if you sold the house for $800,000, you would be required to pay the provider $160,000.

Depending on your provider, you may later have the option to buy back the portion of the home that you sold, if you wish to do so.

Home reversion schemes can be complicated, and can come with risks attached. A key thing to be wary of is that you will be selling a portion of your home equity for less than it’s worth, and will potentially end up owing a great deal more than what you received for it.

For this reason, it is advisable to seek independent financial advice if you are considering a home reversion.

What is an equity release agreement?

An equity release agreement allows you to sell a portion of the value of your home, either receiving a lump sum or instalment payments. It is an alternative option to a reverse mortgage, but likewise comes with its own set of risks.

Say, for example, your home is worth $600,000. You might decide to sell 20% of your equity in your home, and receive $120,000. You would likely have to pay an initial fee to set the agreement up, and would likely be charged ongoing fees.

Your ongoing fees are deducted from the remaining equity in your home. This means that your share of equity in your home decreases over time, while the share owned by the other party (typically a property investment fund) increases.

When the agreement ends, either with your death or a sale of the home, the other party is entitled to a share of the proceeds equal to the equity they hold, and you or your estate will get any proceeds that remain.

Equity release agreements can be complicated, and depending on the fees involved, can greatly reduce your equity in your home over time. For this reason, it is advisable to seek independent financial advice if you are considering one.

Last updated: 11/08/2021

Author: Nina Tovey

As Canstar’s Editor-in-Chief, Nina heads up a team of talented journalists committed to helping empower consumers to take greater control of their finances. Previously Nina founded her own agency where she provided content and communications support to clients around Australia for eight years. She also spent four years as the PR Manager for American Express Australia, and has worked at a Brisbane communications agency where she supported dozens of clients, including Sunsuper and Suncorp.

Nina has ghostwritten dozens of opinion pieces for publications including The Australian and has been interviewed on finance topics by the Herald Sun and the Sydney Morning Herald. When she’s not dreaming up ways to put a fresh spin on finance, she’s taking her own advice by trying to pay her house off as quickly as possible and raising two money-savvy kids.

Nina has a Bachelor of Journalism and a Bachelor of Arts with a double major in English Literature from the University of Queensland. She’s also an experienced presenter, and has hosted numerous events and YouTube series.

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