How do reverse mortgages work?

Reverse mortgages are very different to a standard home loan mortgage. CANSTAR explains how reverse mortgages work, and the legal protections for you as a borrower.

A reverse mortgage is a type of equity release product (ERP). Equity release products come in two forms – credit products and debt-free products – and a reverse mortgage is a credit product.

Common questions about reverse mortgages

Who owns your home?

In a reverse mortgage, you own your home but the bank can lend you money in a lump sum or income stream using the property as security, up to a small portion of the home’s value.

You remain the legal owner of your home at all times, and legal requirements exist to protect your rights so that you can never owe the bank more than a certain portion of your house’s value. This is known as negative equity protection.

However, interest does compound on the loan so your balance can increase significantly, reducing how much you own of your own home (your equity).

You can specify a certain percentage of your home’s value that you want to remain available for your estate, so that you can only borrow up to a certain amount. This is known as protected equity.

What are the repayments?

Repayments and product fees are capitalised on the loan, so the borrower is not required to make any repayments of the principal or interest. The loan is only repaid when you sell your house, move into residential aged care, or pass away.

You can make repayments any time you want to, though. Making repayments means there would be a greater part of the value of your home available in your estate when your house is sold.

Reverse mortgages and the Age Pension

Taking out a reverse mortgage can potentially affect your age pension entitlements, depending on what the money is used for.

We recommend that you speak with a Department of Human Services Financial Information Service officer before signing up for a reverse mortgage, to check how the payments would affect your pension. You can visit an officer in person at your local Centrelink office or a financial information seminar, or you can call Centrelink on 132 300 and ask to speak to a Financial Information Service officer.

There is one type of reverse mortgage that receives a government subsidy: the Pension Loans Scheme created by the government in 2014. However, it has received very few customers, and only 0.04% of Age Pensioners were using a government-subsidised reverse mortgage in 2015, according to the Productivity Commission’s 2015 report. As the Australia Institute points out, the Pension Loans Scheme is unavailable to the full Age Pensioners who would benefit from it most, and is only available to wealthy Australians who only qualify for a part-pension.

Features of a reverse mortgage

To be eligible for CANSTAR’s research ratings, a reverse mortgage home loan product must meet the following criteria:

  • Available to new customers for new loans, not just existing customers.
  • Variable rate mortgage.
  • Available for an LVR of 15% or greater.
  • Disbursements can be received at once as a lump sum.
  • The loan can be used for any personal use purpose.

CANSTAR rates the following cost-related and other features of a reverse mortgage.

Interest rate

The vast majority of reverse mortgages offer a variable interest rate for borrowers. The number of fixed interest rates in reverse mortgages has remained small since 2009.

Find out what the average interest rates and fees are for reverse mortgages here.

Terms of the loan

  • Lending terms: What is the minimum loan amount? What are the valuation details?
  • Protected equity: What specific equity amount is protected from the lender (LVR)? Is there an additional option for protecting a specific equity amount?
  • Security requirements: What types of securities can be used for collateral?
  • Specific conditions: Can the property be rented out? What is the default rate?
  • Committed funding: Is there guaranteed future funding for instalment payments?

Product functionality

  • Offset facility: Is a mortgage offset account available?
  • Redraw facility: Is a redraw facility available?
  • Additional repayments: Is there flexibility to make additional repayments?
  • Split facility: Is there the ability to have different interest types? Are fees charged to have a split loan?
  • Portability: Can a loan be transferred from one house to another if you move house?
  • Top-up facility: Is there the ability to top-up the loan?

Default

  • Definition of default: What events may cause default?
  • Action after default: What specific action is taken by lenders if the borrower is in default?

Fees

  • Loan fees: What fees are charged?

Application and approval

  • Loan application and approval: How easy is the loan application and approval process?

What is the difference between a standard home loan and a reverse mortgage?

The main difference is that with a reverse mortgage, it does not become repayable until you sell your property, move into residential aged care, or pass away. When your home is sold, only the amount you owe on the property is taken out of the sale proceeds, meaning you can still leave your family the rest of the sale proceeds in your will.

We’ve compared the other major differences between standard home loan mortgages and reverse mortgages based on data from ASIC (2011, 2015), Deloitte (2015), and reverse mortgage providers:

Reverse Mortgage Standard Mortgage
Debt Debt
$3.66 billion market size,

Approx. 10 providers in Australia in 2015

$1.4 trillion market size,

Approx. 101 providers in Australia in 2015

Eligible if aged 60+, depending on type of home

and value of home

Eligible based on income and employment risk
Paid in a lump sum, income stream, or line of credit Paid in a lump sum or line of credit
Max equity withdrawal: 15-45% (note, providers differ) Max equity withdrawal: 95% (note, providers differ)
Most commonly variable interest rate Fixed or variable interest rate
Interest and loan both repaid by sale proceeds after death or moving out Interest repaid in regular instalments, and loan must be repaid in loan term
Generally provision available so that borrower does not owe more than value of home (unless loan was taken out before Sept 2012) Possible to owe more than value of home, if value falls or interest repayments are missed

Legal protections for borrowers

Reverse mortgage regulations were created under the National Consumer Credit Protection Code 2012 (NCCP) and ASIC Regulatory Guide 209 (Credit Licensing: Responsible Lending Conduct). These regulations include the following protections for borrowers:

  • Negative Equity Protection: You cannot go into debt beyond the value of your house. (Based on the No Negative Equity Guarantee in SEQUAL’s 2004 self-regulation code of conduct.)
  • Maximum LVRs: You can only take out a loan up to a maximum value ratio according to your age, so that you have adequate capital left over if you need it.
  • Legal advice: You must get independent legal and financial advice before signing up for a reverse mortgage.
  • Equity and cost projections: From 1 March 2013, ASIC requires your credit provider to go through reverse mortgage projections with you before you take out a reverse mortgage, stating how your home equity will change over time and how interest rates can impact on this. Your provider must do this in person, using the ASIC MoneySmart reverse mortgage calculator, and you must receive a printed copy to take away with you.
  • Information statement: From 1 March 2013, ASIC requires your credit provider to give you a reverse mortgage information statement, explaining how a reverse mortgage works, how costs are calculated, what to consider before making a decision, and useful contacts for more information.

Different providers offer different levels of value when it comes to the features available in a reverse mortgage. Compare your options on our website:

Compare Reverse Mortgages with CANSTAR

Read the CANSTAR Guide to Reverse Mortgages for more information.

If a reverse mortgage isn’t suitable for you, try out our Home Loan Borrowing Power Calculator to calculate how much you can borrow via a standard home loan.

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