What is a reverse mortgage? It is a niche question but one that is going to become increasingly asked as populations get older.
The majority of people who should be asking, ‘What is a reverse mortgage?’ are those approaching retirement but not yet there (10-15 years away). It is a common misconception that retirees are those who need to think about the advantages of a reverse mortgage, but planning is everything when it comes to your financial health which is why it is best to ask these questions (and get the answers) years before you need to start implementing changes.
What is a reverse mortgage… exactly?
A reverse mortgage is predominantly targeted towards retirees as it allows you to borrow money using the existing equity in your home as security. You may also be able to use the equity in an investment property or holiday home (to keep your Permanent Place of Residence free from a mortgage) but some lenders may not accept this.
A reverse mortgage is more complicated than the typical mortgage a first home buyer or investor usually comes across. There are many ways you can shape a reverse mortgage to suit your financial needs. For instance, you can either earn a regular stream of income through a reverse mortgage, receive a lump sum, earn a line of credit or mix these options together.
You don’t usually pay interest on your reverse mortgage (interest is higher in a reverse mortgage than regular mortgages). Instead, it is added to the value of the loan and compounds.
You eventually pay the loan when you sell the home (for instance, if you move to an aged care facility).
Note: as Australia’s general population ages in the future and a growing portion of the population enter retirement with mortgages, there will be a growing demand for refinancing options such as a reverse mortgage. However, regulation will likely grow as a result so that the economy does not become reliant on unhealthy risking practices. This may mean it will become harder to enter into a reverse mortgage.
The benefits of a reverse mortgage
- The greatest benefit of a reverse mortgage is that it allows you to leverage the value of your home to maximize your comfort in the later stages of your life. There is also a significant flexibility inherent in the many ways in which you can take out a reverse mortgage.
- For those contracts entered as of 18 September 2012, you are no longer liable for any debt you incur that exceeds the value of your home. If you sell your property and the price the house receives does not match the debt you owe, the lender cannot pursue you for this outstanding fee. This is a great benefit as it provides some ease of mind for those concerned about major fluctuations in the market.
- The amount you can borrow increases with your age, by approximately 1% of the value of your home for each year over the age of 60 (where it begins at approximately 15% of the value of your home).
- You can often protect a portion of the value of your home, providing you with an assured deposit for potential aged-care costs (such as the deposit for an aged-care facility).
- Your lender must provide you with budget calculations that provide an estimate of the costs associated with fluctuations in the market or in the interest rate, and they must provide this to you in written form. You can use this to talk with a financial adviser about the feasibility of a reverse mortgage.
The limitations of a reverse mortgage
- Interest rates for a reverse mortgage are typically higher than regular loans. On top of this, without proper planning, the compounding of interest on your reverse mortgage risks giving you a shock when it comes time to pay the loan.
- Generating income from a reverse mortgage can affect your pension.
- A reverse mortgage can be quite complicated; as can the potential eventualities of taking out a reverse mortgage. For instance, if you unfortunately pass away as the sole owner of the home with your partner remaining behind, they may have to leave the home so that it can be sold to pay the loan. It is important to seek thorough advice on how a reverse mortgage will affect your particular financial and living situation.
- Some companies offer a stream of income in place of the capital gains made on your property. This can be risky as your income (which is fixed) may be dwarfed by the capital gains your home accrues (in the case of a surging market). In this case, you may not be covered by consumer laws if you wish to dispute such an arrangement.