Reverse Mortgages
Reverse mortgages: How you can use your home to fund your retirement.
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If you are retired, or close to retirement, and in need of funds, you can use the equity in your home to secure a loan. This is known as a reverse mortgage.
Though reverse mortgages are not as common in the Australian market as they once were, they are a useful product, with cheaper interest rates than the average credit card, and no regular repayments required. In this article, we explain how reverse mortgages work, the options to consider, and the pros and cons to help you decide if this is the right product for you.
What is equity?
If you’ve ever looked for a home loan, you’ll probably have heard the word “equity” thrown around. It is particularly important to understand how equity works if you’re applying for a reverse mortgage.
Your equity is the portion of your home that you own. If your house is paid off, and you own it outright, then you have 100% equity. If you have a mortgage on your house, then your lender owns part of it. For example, if your house is worth $500k and you have a $100k mortgage on it, then the bank owns 20%, and your equity is 80%.
How does a reverse mortgage work?
A reverse mortgage lets you borrow money using your house as collateral. Unlike a normal loan, you don’t have to make any repayments until you move out, sell your home, or pass away. The lender is paid what they are owed – including all fees and interest – from the proceeds of the sale.
This is where equity becomes important. As time goes on, the interest and fees you owe are added to the loan amount. As the loan amount increases, your equity decreases. In other words, over time, your share in the property decreases and the lender’s share increases.
Am I eligible for a reverse mortgage?
To get a reverse mortgage, you must be aged 60 or older. You also need to own your home outright.
If you’re still paying off your original mortgage, from when you purchased the house, then the lender may still agree to give you a reverse mortgage. However, as part of the reverse mortgage contract, they will likely insist that you pay off all previous loans on the house using the reverse mortgage funds.
How much can I borrow?
Each lender has slightly different rules on this, but in general, you can usually borrow 15-20% of the value of your home when you are 60 years old. The older you get, the more you can borrow. For example, at age 65, you can usually borrow around 20-25% of the value of your property.
As a rough guide, for each year you age beyond 60, you can borrow one per cent more.
What are my payment options?
You usually have the option to take the money as a lump sum, an income stream, or a line of credit.
Lump sums are useful for big expenses such as renovations, medical bills, weddings, etc.
If you are struggling with your weekly expenses and you want some money to boost your income, then you may prefer to take the reverse mortgage as an income stream.
It is important to note that you only pay interest on the money you draw. So, if you get approval for a $50k line of credit, but you only use $10k of it, then you only pay interest on the $10k.
Because the interest on a reverse mortgage can add up very quickly, it’s important to consider carefully, when you’re choosing how you’ll be paid the funds. Different payment methods may also have different admin fees involved.
What’s the interest rate on a reverse mortgage?
The reverse mortgage rates are usually higher than normal home loan rates, by around 1-2%. The most recent figures from the RBA, in February 2020, found the average rate on a reverse mortgage was 6.2%. At that time, the average variable home loan rate was 4.8%.
The really important thing to remember is that the interest is compounding, that is to say, you will pay interest on your interest. If you aren’t going to be making any repayments, the amount you owe can grow exponentially.
Below is a table that shows how long it takes for your loan to double if you don’t make any repayments. In this example, we assume there are no ongoing fees.
| Interest Rate | Years for loan value to double |
|---|---|
|
3.0% |
23 |
|
3.5% |
20 |
|
4.0% |
18 |
|
4.5% |
16 |
|
5.0% |
14 |
|
5.5% |
13 |
|
6.0% |
12 |
|
6.5% |
11 |
|
7.0% |
10 |
What features should I look for when shopping for a reverse mortgage?
Voluntary repayments
Though there are no compulsory repayments on a reverse mortgage, most lenders will allow you to make voluntary repayments. The more you can pay off, the less interest you’ll owe in the long run.
Interest rate options
Most lenders in Australia only offer variable interest on reverse mortgages. However, there are a select few that offer fixed or split rates.
In general, fixed-rate reverse mortgages are less flexible than variable-rate reverse mortgages, and they have fewer features. For example, you may not be able to make voluntary repayments during the fixed-rate period, or you may be charged a fee for doing so. If you want to exit a fixed-rate contract, either by paying the mortgage off or by refinancing with another lender, you could be charged termination fees.
On the other hand, your interest rate won’t change over the fixed-period, so there are no nasty surprises. If the average market interest rate rises, you won’t be impacted.
Equity protection options
Some lenders will allow you to protect a portion of your equity. Effectively this means that there is a limit on the interest your reverse mortgage can accrue.
You can use your protected equity at a future date to borrow more money for unexpected expenses; to pay for aged care once you sell your home; or to leave as an inheritance for your next of kin.
It is important to note that equity protection may limit how much money the lender approves you for. They may also charge you an administration fee.
Offset accounts
If you put your pension income and savings into an offset account, it can significantly reduce your interest costs. For example, if you have a $100K reverse mortgage and $20K in your offset account, then you only pay interest on $80K.
The offset account works a lot like a regular bank account, in that you can make payments and withdrawals using a debit card whenever you like, and the lender can charge you an admin fee for running the account.
What are the fees on a reverse mortgage?
These are the standard fees that may apply to a reverse mortgage:
Establishment fee: $500-$1000
Ongoing administration costs: $0-$12
Loan termination fee: $300-$400
Depending on which features you choose to have, you may be charged other fees as well.
Who takes out reverse mortgages?
According to an ASIC report into reverse mortgages published in August 2019, 70% of Australians aged 55-85 own their own home and have a collective $500 billion in home equity (over the age of 65).
Reverse mortgages are aimed at retirees looking to bolster their retirement cash flow. Though the lure of unlocking money from something you already own seems promising, it can lead to financial difficulty later down the road.
Only two financial institutions hold over 80% of all reverse mortgages. After a 7:30 expose and findings the Royal Commission into the financial services sector over 2018-19, Commonwealth Bank, BankWest, Westpac, and Macquarie Banks all ceased offering reverse mortgages.
As a result, ASIC is attempting to enforce stricter rules around reverse mortgages to ensure consumers are better protected.
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The pros and cons at a glance
PROS
No repayments required
You don’t have to make any repayments until you sell your home (unless you want to).
Cheaper than a credit card
Reverse mortgages have lower interest rates than credit cards, making them more affordable.
Flexibility
You can take the reverse mortgage payout as a lump sum or an income stream
Strict regulations
Government safeguards apply so that you never owe more than you can afford.
CONS
Pension payment impacts
A reverse mortgage can potentially lower your pension payments.
Compound interest
With zero repayments, the interest on a reverse mortgage can accumulate very quickly.
Dependents not protected
If the person listed on the loan agreement dies, their dependents can be evicted from the home.
