How much will a reverse mortgage cost you?
Calculating the potential costs of a reverse mortgage can be tricky. We'll break it down step by step for you.
Reverse mortgages allow older Australians to live in their homes while accessing some of their home equity to spend as they need it.
To determine if a reverse mortgage is right for you, you'll need to understand just how much it will cost you. There are many factors to take into account, including the amount you borrow, how you access it, the interest rate and the loan fees.
To give you a clearer breakdown of how it works let's examine a hypothetical scenario involving a pair of older Australian borrowers. Keep in mind that this is an estimate only, because the actual cost of a reverse mortgage depends on factors that aren't always in the borrower's control, such as when you sell or the future value of the property.
Example borrower scenario
Bill and Margaret are a married couple living in Western Sydney. Bill is 76 and Margaret is 75. Age is important because with a reverse mortgage you're able to borrow more as you get older.
For the purpose of this calculation we need to use the age of the youngest borrower, which is 75.
Bill and Margaret live alone and are not currently receiving any government assistance. They have no debts.
Bill and Margaret own their home outright and it is valued at $800,000. The value of the property is important because this determines their equity and the amount they can borrow through the reverse mortgage.
Every reverse mortgage also has a maximum loan to value ratio (LVR). This is the amount of equity you are able to access, expressed as a percentage.
A reverse mortgage with a 40% LVR allows you to access up to 40% of the value of your property. But the age of the youngest borrower usually brings the actual LVR down further.
When calculating your reverse mortgage costs you also need to anticipate the future growth in your property's value. If you take out a reverse mortgage over 5 or 10 years it is unlikely that your property will stay at the same value.
For the purpose of this example we will assume that Bill and Margaret's property will see a conservative 3% annual price growth.
The reverse mortgage
With Bill and Margaret's information we have a rough idea of what they could borrow. But the amount depends on the reverse mortgage product they choose. This is because every lender has different LVR limits
And we also need to factor in fees and interest rates, which differ for every loan and lender.
For this calculator, let's use the Standard Reverse Mortgage from Heartland Seniors Finance. This lender sets the maximum loan amount at 30% of a property's value when the youngest borrower's age is 75.
30% of $800,000 equals $240,000. This is the maximum amount Bill and Margaret could borrow.
Rates and fees
We also need to know about the loan itself, including the fees and the interest rate. Using Heartland Seniors Finance as an example again we have the following details:
- Interest rate: 5.80% (comparison rate 5.82%*)
- Settlement fee: $495
The interest rate is the most important factor here but the fee is important too. Some reverse mortgage lenders charge a fixed fee, while others charge a fee that varies depending on the amount borrowed. This can add up to a much larger fee, making the loan more expensive.
Note that other fees may apply depending on a borrower's circumstances. Most reverse mortgage lenders charge a fee at the end of the loan as well.
Calculating the costs
Now we can see how much the reverse mortgage will cost them. We just need to know how much Bill and Margaret want to borrow and estimate when they will sell the house and repay it.
To estimate their costs we will use MoneySmart's reverse mortgage calculator. This is a free government tool for borrowers.
Margaret and Bill would like to borrow $10,000 a year, for the next five years, to fund several small renovations and a few holidays. Relative to the value of their property this is a fairly conservative amount to borrow.
Last, we need to assume a time when they will sell the house and repay the loan. Let's say they stay in their home until Margaret is 90, so 15 years from now.
In this scenario Bill and Margaret borrow $50,000 over 5 years and pay it back 15 years later with interest. Here's what it costs them:
- Loan amount: $50,000
- Total amount owed (including interest): $101,632
- Projected home value: $1,246,374
- Remaining equity: $1,144,742 (92% of the property's value)
So in this example we can see that the $50,000 ends up costing Bill and Margaret a little over double that by the time they repay it.
But this still leaves them owning 92% of their property (assuming a 3% growth in prices). And given the projected price growth, that's still more than the current value of their home.
What if Bill and Margaret borrowed a lot more? What if they wanted to borrow the maximum amount they can, 30% of their equity, in one lump sum?
In this scenario, assuming they sell the house in 15 years, their costs would be as follows:
- Loan amount: $240,000
- Total amount owed (including interest): $570,089
- Projected home value: $1,246,374
- Remaining equity: $676,285 (54% of the property's value)
In this scenario Bill and Margaret have pulled out a lot more of their equity and at the end they own 54% of the property, or $676,285. Even factoring in price growth, this ends up being less than the current value of their property.
This is a more extreme example, but it is a useful illustration of how reverse mortgage debt works.
Hopefully these example calculations make it easier to understand just how a reverse mortgage works.
Please note the information set in this article may change from time to time. Every situation is different – this information has been prepared without taking into account your needs, objectives or financial situation. If you are considering a reverse mortgage, we encourage you to understand how it may affect your personal circumstances – talk to friends and family, speak to professionals, and use the resources and tools Heartland has available. Subject to complying with the terms and conditions of your loan, you will not owe more than the net sale proceeds of your home and you can keep your home for as long as you choose. There is no assurance that property values will increase over time, and property values may also decline. Applications are subject to loan approval criteria. Terms, conditions, fees and charges apply. Credit provided by ASF Custodians Pty Ltd (ACN 106 822 780 / Australian Credit Licence No. 386781).
*Comparison rate is based on a loan of $150,000 over a term of 25 years. Please note the comparison rate only applies to the examples given. Different loan amounts and terms will result in different comparison rates. Costs such as redraw fees and costs savings, such as fee waivers, are not included in the comparison rate but may inﬂuence the cost of the loan.