What is it?
Reverse mortgages are a phenomenon which operate in reverse to a traditional mortgage where by the longer you have the loan – the bigger it gets. It is a mortgage option that allows qualifying individuals to release a portion of their home’s equity without necessarily incurring monthly mortgage payments. Access to your property’s equity gives you financial freedom to spend money on essential items.
How do I know whether it is good for me?
A reverse mortgage can be tricky business and is only really a good option for a select few. To qualify for a reverse mortgage, you must meet the following requirements:
Be at least 60 years of age
Own a home (be mortgage free)
Have never defaulted on your mortgage payments
Home must be your primary residence.
Essentially, it is a good option for those who are cash poor and require finance to fund medical expenses or home renovations, for example.
How do they work?
A reverse mortgage aims to have a significant impact on your finances, relationships and your quality of life throughout retirement. It was initially established to help retirees with limited income use the accumulated wealth in their homes to cover basic monthly living expenses, home renovations and health care.
The option is perfect for retirees or those looking to retire due to their typical asset-based wealth. This usually means they have limited cash available on hand to finance lifestyle needs, and instead, reverse mortgages help to convert the value of their home into ready cash.
Using the equity in your home as security, a reverse mortgage can be paid as a lump sum, a regular stream of income, a line of credit or a combination of these options. Instead of making monthly payments to a lender, as with a traditional mortgage, the lender makes payments to the borrower.
You are not required to pay back the loan until the home is sold or otherwise vacated. As long as you live in the home, you are not required to make any monthly payments towards the loan balance, but you must remain current on your property taxes, homeowners insurance and condominium fees (if applicable). Interest is charged like any other loan, except you don’t have to make repayments while you live in your home. Interest compounds over time and is added to your loan balance.
Am I protected by any legislation?
As of September 2012, the Australian Government introduced statutory ‘negative equity protection’ on all new reverse mortgage contracts. This means you are unable to owe the lender more than your home is worth (the market value or equity) at the end of your loan term.
When the reverse mortgage contract ends and your home is sold, the lender will receive the proceeds of the sale and you cannot be held liable for any debt in excess of this (except in certain circumstances such as fraud or misrepresentation). Fortunately, if your home sells for more than the amount owed to the lender, you or your estate will receive the excess funds.
How much can I borrow?
The amount you are able to borrow is based on two factors – your property’s worth and the age of the youngest borrower.
Basically, the older you are, the more you can borrow but different lenders have different policies on how much they will let you borrow.
As a general reference, the maximum amount you can borrow if you are 60 years of age is likely to be 15-20% of the value of your home. You can usually add 1% for each year older than 60. That means if you are 70, the maximum amount you could borrow would be about 25-30%.
The minimum amount you can borrow will depend on your provider.
How much should I budget?
Essentially, the cost of the loan depends on the interest rate and fees available from your lender. The main issue is that as the interest compounds, the debt grows.
Keep in mind that some reverse mortgage products allow you to protect a portion of the value of the property. For example, you may want to save a lump sum of around $200,000 in case you need to pay any upfront payments for aged care facilities.
To give an example of associated costs, retirees should budget approximately $1000 as an establishment fee and then a further (on average) $15 per month service fee, depending on their lender. Furthermore, interest for reverse mortgages are usually higher, around 1-2 percent more than traditional loans, somewhere between 7 and 8 per cent.
·Debt is capped at the value of your home.
·Helps cash poor homeowners fund retirement.
·Options include a regular payment, line of credit or lump sum.
·Can enable homeowners to stay in their own homes.
·You can always sell your home and pay out the debt.
·Aims to improve your finances, relationships and your quality of life
·Higher interest rates apply.
·Interest starts accumulating from the outset.
·If you are sole owner, any other persons who live in the property may have to vacant when you die.
·You have to repay the loan when you move out.
·You’re still responsible for home costs.
·The more you borrow now, and the younger you are, the less equity you will have in your home in the future.
Sounds pretty good don’t your think? Believe us, you aren’t the only one who thinks so. But be careful when considering a reverse mortgage as it is generally a risky option. It is mandatory you seek financial and legal advice before applying for a reverse mortgage, to ensure that you understand the costs, options and risks involved. Many reverse mortgage customers also discuss the situation with their children. It's best to meet that advisor in person, taking an adult child or trusted adviser with you.
This article is general in nature and does not take into consideration your individual circumstances. It is recommended that you gain independent financial advice before taking out any financial product.