The ability to unlock the equity that you have built up in your home could be both tempting, and in some instances, beneficial.
This is especially true for those who need to access funds but, like most Australian’s, have the majority of their assets tied up in the family home.
A reverse mortgage can help unlock this equity, however, those considering such a product should consider the following factors, prior to drawing down against their home.
Reverse mortgages tend to have higher interest rates than regular mortgages. As at July 2017, the average rate for a reverse mortgage in Canstar’s database is 6.27% compared to the average for Residential Standard Variable (P+I) loans of 4.49%.
As at July 2017, the average advertised rate for a reverse mortgage in Canstar’s database is 6.27% compared to the average for residential standard variable (P+I) loans of 4.49%.
The effects of compounding interest are often underestimated by consumers. While regular mortgages see the principal owing decrease over time, the opposite is true for reverse mortgages, with compound interest making the amount owing against the property balloon out over the longer term.
While regular mortgages see the principal owing decrease over time, the opposite is true for reverse mortgages, with compound interest making the amount owing against the property balloon out over the longer term.
For instance, a consumer who borrows $50,000 against their property at age 70 with the market average rate of 6.27% could have an amount owing of over $90,000 by the time they turn 80 and over $170,000 by the time they reach 90 – and this doesn’t include any fees or charges that could also be accruing interest along the way.
Source: Canstar Research
There are a number of fees that can form a part of a reverse mortgage, the common ones are ‘upfront establishment fees’, ‘ongoing monthly/annual fees’ and ‘discharge fees’.
It is important to note that the fees will be capitalised into the amount owing on the mortgage, meaning interest is also being charged on this amount for the duration of the loan.
This could mean that a $1,000 upfront fee could cost the consumer well over $3,000 once 20 years of compounding interest has accumulated.
The impact on your future financial needs
While there are certainly instances where accessing the equity in your home could help in meeting immediate expenses, it is important to ensure that you are aware of the potential impact to the long term equity in your home and whether this will provide sufficient cover for future expenses, such as the cost of moving into a retirement village or aged care needs.
Since 2012, there has been in place ‘negative equity protection’ on all new reverse mortgage contracts, protecting borrowers from owing the lender more than the value of the home at the time of sale.
However, the risk that the majority of equity that you have accrued over your lifetime will be eroded by compounding interest remains, potentially leaving little proceeds at the time of sale once the loan has been repaid.
Eligibility for the Aged Pension
Centrelink allows pensioners to draw a lump sum from a reverse mortgage, however, there a number of conditions that you need to be aware of.
If you are drawing down a lump sum, only $40,000 of the total amount drawn down will be exempt from the assets test.
However, it will only remain exempt for 90 days, so you will need to spend this money fairly quickly to avoid it impacting your pension eligibility. It should also be noted that while the lump sum will not immediately impact the assets test, it will be subject to deeming by the income test from the day it is drawn down.
But it’s not all bad news
While there are some drawbacks that could have an adverse impact on consumers in their retirement, reverse mortgages remain a valuable product proposition to consumers who are aware of how they work.
Take for instance a retiree who requires funds for an immediate expense that they will be able to repay over the coming years, reverse mortgages can provide a way for this consumer to unlock the equity that they have in their home to meet this expense, generally at a lower rate than what is available from unsecured credit products (e.g. personal loans, credit cards, etc.).
As with all financial products, it is important to understand the costs associated, weigh up the pros and cons, and when unsure, seek professional advice relating to your individual circumstances.