What is a reverse mortgage?

If you’re aged 60 or over and own your own home you may be able to tap into some money by taking out a reverse mortgage. So what is a reverse mortgage and how does it work? We take a closer look at some of the pros and cons.

A reverse mortgage allows you to take out a loan using the equity in your home as security.

The loan will have to be repaid, plus interest and any fees, at some point. But a reverse mortgage could also mean that you can stay in your own home and release some of the equity you have to help pay for things such as living expenses, renovations, a holiday or any medical bills.

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, add 1% for each year over 60,” it says. “So, at 65, the most you can borrow will be about 20–25%. The minimum you can borrow varies, but is typically about $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, or as a regular payment, or even a combination of the two.

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 when 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.

Not all lenders offer a reverse mortgage so you may have to shop around to find one that suits.

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.

Darren Moffatt, CEO of Seniors First, a mortgage broker firm specialising in servicing clients aged 60 and over, says the impact on any Age Pension depends on how the reverse mortgage money is used.

“If the money is taken as a lump sum and spent on an asset that is assessable by Centrelink, such as a car, the value would count towards the asset test of the pension,” he says.

Likewise, if the money builds up in a savings account it could also potentially count in the asset 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 die, as the loan would have to be paid out of any money you hope to pass on as any inheritance to others.

You might want to consider getting some independent financial advice to see what impact any reverse mortgage payments would have for you.

What are the potential pros and cons of a reverse mortgage?

As with any financial product, you should look at the potential pros and cons of a reverse mortgage to see if it suits your needs.

Tony Xia, director of The Mortgage Agency, spoke to Canstar about some of the things you need to look at when considering whether a reverse mortgage is right for you.

“It all comes down to personal preference for what the funds are used for,” Mr Xia said.

“Reverse mortgages are generally used for asset-rich, cash-poor individuals. Thus if money is needed for medical purposes, for example, and you have no cash on hand, then a reverse mortgage could be an option to consider.”

Mr Xia details some of the potential pros and cons of a reverse mortgage.

What are the potential pros of a reverse mortgage?

• If you’re in any financial difficulties or have cash flow problems due to not working, a reverse mortgage could relieve the stress.
• 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 care services or medical expenses without the need to repay the money immediately.

What are the potential cons 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 when it’s time to sell.
• 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.

Moneysmart says reverse mortgages taken out from 18 September 2012 have 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).

Mr Xia also said it was a good idea to talk to an independent financial adviser before making any decision on a reverse mortgage.

You need to check what fees and charges may apply, and read the Target Market Determination (TMD), key information statements and other relevant product documentation.

Cover image source: fizkes/Shutterstock.com