With interest rates virtually nothing, reverse mortgages may be the lifeline that cash-strapped retirees need right now. But, proceed with caution.
Sometimes referred to as "lifetime loans", reverse mortgages use the equity in your property as security for a loan. Unlike a normal loan, with a reverse mortgage, repayments are not required. Interest is added to the loan principal and the whole lot is paid off when you sell your home or die.
Those who promote the use of reverse mortgages say that while Australian retirees have over $1 trillion of equity in their homes, many of them don’t feel particularly wealthy. Too many have no liquid capital at all and can’t make their income stretch far enough.
Being cash strapped though doesn’t mean asset poor.
A reverse mortgage is a way to use that equity in your home that would otherwise just sit idle.
So if you do your research, you can have your cake and eat it too – your home can be somewhere to live as well as a tool to help fund retirement.
The amount you can borrow depends on your age and what your home is worth.
You can normally borrow from 15 to 20% of the value of your home at age 60, and that increases by about 1% every year. So if you're 75, you'll be able to borrow up to 30 to 35%.
However, reverse mortgages have some big downsides that should not be underestimated.
A common concern is that as there are no repayments, the interest is continually being added to the loan balance (so, you are paying interest on interest).
Interest rates on these products are very high, the average rate at the moment being somewhere between 5 to 6%.
So if you borrowed $100,000 today at 5%, in 10 years time you’d owe about $162,000, in 15 years $208,000 and in 20 years $266,000. It’s the miracle of compound interest but in reverse.
Could this mean that you might end up owing more than the house is worth, meaning a forced sale?
The good news is that negative equity protections legislated in 2012 prohibit this from happening.
And when the time comes, if the home is sold for less than the amount of the principal and interest owed, well, that will be the banks problem, not yours.
Family disputes can also happen.
Some financial planners, accountants and lawyers won’t give advice on reverse mortgages because there's a degree of risk not just to the customers but also to their kids. There have been cases where advisers have been sued by deceased estates:
Mum and dad said we'd get the house, they'd never have signed up for this if they knew what they were doing, so we're going to sue.
There’s red tape to deal with too.
Lenders require customers to get the green light from accountants, financial advisers or lawyers. This takes considerable time and money.
Financial advisers, for instance, need to model possible scenarios that show what will happen to your equity over different timeframes, and this can set you back a lot of money.
Taking out a reverse mortgage could also impact your pension, because the principle you draw will be considered an asset (your primary residence is usually exempt from the assets test), which could reduce, or disqualify you from, the age pension.
The reverse mortgage may also leave you with far less money to live out your life when it does come time to sell up.
If you have to sell your home so you can move in to an aged care facility, your obligation to repay the reverse mortgage loan when you sell your home will reduce the amount you have available for payments aged care.
As with all financial decisions, understanding what can go wrong is the best defence against nasty surprises down the track.
Here’s some things to consider:
The MoneySmart website has a great reverse mortgage calculator that shows how much of your home you'll end up owning over different time periods, home values, interest rate and fees.
My advice though, is to get some advice.
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