Consider unlocking the equity in your home and improving the quality of your retirement with a reverse mortgage.
Whether you need funds to diversify an investment portfolio, or to cover the costs of a home renovation or an overseas trip, a reverse mortgage may help you fund your retirement- whatever your plans may be.
Fuelled by an ageing population, an increasing cash rate and rising property values, Australia’s reverse mortgage industry is forecast to surge over the next five years. According to recent research from IBISWorld (2015), the industry is expected to increase at an annual rate of 5.4% between 2016 and 2021.
While often perceived to be a risky finance option, many lenders are becoming more comfortable in offering reverse mortgages to seniors due to greater industry regulation. For instance, recent legislation introduced the ‘negative equity protection’ scheme, which means you’re protected from owing more than the value of your home.
As you near retirement age, it is likely that you are ‘asset rich’ but ‘cash poor’. As a result, you may need to tap into your equity to complement your lifestyle needs. You can take out a Reverse Mortgage, which is similar to a Home Equity Loan, and access the equity you have built up in your home to ease financial pressure and improve your quality of life.
Before taking out a reverse mortgage, you should seek independent financial and legal advice.
Here are some things you should consider prior to deciding whether a reverse mortgage is right for you.
Reverse Mortgage Comparison
Also known as a ‘reverse home loan’, ‘senior finance’ or an ‘equity release loan’, reverse mortgages are a common form of home equity release in Australia.
Allowing borrowers from the age of 60 to convert equity into cash for a worthwhile cause, a reverse mortgage enables you to borrow money against the equity you have in your home as security.
The amount of equity that can be released is determined by your age and the value of the security of the property.
Once the loan is approved, you can access your money to use however you wish, and the lender will proceed to charge interest on the amount owing. Generally, the amount of interest is calculated daily on the outstanding balance and represented as a single amount each month in arrears.
There are no repayments required by you to repay a reverse mortgage while it is current. Instead, the interest payments are added onto the loan balance each month.
The loan amount can be taken as one of the following, or a combination of the following:
- A lump sum.
- A regular income stream.
- A line of credit
The debt can be repaid to the lender when:
- You decide to sell your home.
- The last surviving borrower dies.
- The borrower moves into an aged care facility.
- Supplement retirement income: A reverse mortgage enables you to access additional funds, or existing equity in your home, without having to downsize or sell your home.
- Flexible payments: With a reverse mortgage, you are not obliged to make monthly repayments but can choose how you receive the funds through flexible options such as a lump sum payment or a line of credit, among others.
- Industry regulation: Recent legislation protects borrowers from owing more than the value of your home with the ‘negative equity’ protection. That is, when the 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.
- Minimum loan amounts: You can restrict your loan amount to as little as $10,000. Some lenders will help you keep your exposure low so it has less of an impact on your future finances. In addition, some lenders allow you to protect a portion of the property value. For instance, you might want to ensure that you have $200,000 left in case you need it to cover accommodation costs for an aged care facility, so ensure that you discuss this with your lender when setting up the loan.
- Higher interest: Interest charges are generally higher than typical mortgages. An average variable rate on a reverse mortgage is (at the time of writing) around 6.25%- 7.25%, however this will vary from lender to lender. As the interest compounds, the loan amount can increase rapidly.
- Pension eligibility: A reverse mortgage may affect your ability to qualify for the pension. Contact the Department of Human Services to find out how it could impact your eligibility to see if you can structure your reverse mortgage in a way that does not interfere with your pension benefit.
- Break fees: If you fix the interest rate on your reverse mortgage, the charges to break the agreement can be costly.
Unlike traditional mortgage products, with a reverse mortgage you don’t have to make monthly repayments to the lender. Instead, you receive the loan either through monthly payments, a line of credit or a lump sum- or a combination of these- and then repay the debt when you sell your home or meet one of the above criteria.
Another point of difference is that the amount you’re able to borrow isn’t determined by your income- like a traditional mortgage- but rather you’re able to borrow a certain percentage of the available equity you have in relation to the value of your home.
Is there an alternative to a reverse mortgage?
If you want to access equity in your property, but you don’t want to take out a reverse mortgage, the primary alternative is to sell or downsize your home. However, this will incur substantial costs such as stamp duty, agent and conveyancing fees so it’s a good idea to weigh the benefits and risks involved.Back to top
Work out the amount you can borrow
A reverse mortgage calculator can help you get an idea of how much you're able to borrow. Generally, this will be 15 - 45% of the property value, so be conservative with your estimate of how much your home is worth. The calculator will also take into account the age of the youngest borrower in order to estimate the percentage of your home’s value that can be borrowed.
While lenders have individual guidelines about how much you can borrow, generally the older you are, the more you can borrow.
Lenders are conservative about the amount of equity you can access with a reverse mortgage which is why younger borrowers, aged 60, are limited to a maximum of 15% of the available equity in the home.
For example, if your home is valued at $500,000, you're only able to access a maximum of $75,000. Even if you add five years of interest to this loan amount, the value of your home is still substantially higher than the remaining debt.
Once the value of your home is estimated, the lender will allocate a specific percentage amount that you’re able to borrow. As mentioned earlier, this may be 15- 45% of the value of your home, depending on the age of the youngest borrower.
Incremental percentage amounts may apply with some lenders for the ages shown in the table below. That is, if the youngest borrower is 63, the percentage amount may increase to 18% of the home value. If the youngest borrower is 68, the percentage amount may increase to 23% of the home value, and so on.
You can generally add 1% for each year older than 60. Be mindful that if you borrow the maximum amount now, you may not have access to any more funds further down the track.
You can use a reverse mortgage calculator to help you estimate how much you may be able to borrow, which may help you decide if a reverse mortgage is right for you.
The below table is an estimate of the percentages some lenders may consider based on age:
|Age of Borrower||Percentage of PropertyValue Available|
Case Study 1: Peter and Pam
Peter and Pam worked hard for many years to fund a comfortable retirement. Their property investments provided them with a stable income, however these income-producing assets depreciated after the GFC reduced their rental income by 5%. As they were advised not to sell their assets while the market was in a slump, they opted for a reverse mortgage.
They chose to receive their funds in the form of instalments each month instead of taking a lump sum amount. This gave their income a supplemental boost and allowed them to resume their comfortable lifestyle without losing any of their assets. Once their income from interest and dividends had returned to normal levels, they decided to suspend any further instalment payments from their reverse mortgage. They always have the option of starting them up again at a later point.
The largest costs associated with a reverse mortgage apart from interest are the application and interest charges.
Establishment fees can be high and interest rates are usually much higher than those set on regular mortgages. Set up costs for a reverse mortgage may vary between $1,500 - $2,000 depending on the lender. This typically covers the lender application fee, government charges, legal charges and any broker fees.
The interest charges will compound with each month, with interest being charged on previous interest amounts that have been capitalised onto the loan. For this reason, it's important to use the right type of calculator that will consider this compounding effect.
To minimise the risk of paying too much interest, you should only borrow what you need. Carefully consider the current value of your house and the amount of equity you intend to borrow from it. Speak to a mortgage broker or financial planner to determine how much the interest charges will be in total.
When do I repay a reverse mortgage?
You aren’t expected to repay the reverse mortgage in full until:
- You sell the home;
- You move into an aged care facility; or,
- The last surviving spouse passes away.
Reverse mortgages are beneficial for those people who find they suddenly don't have enough money to fund their retirement or lifestyle plans.
Whether you choose to fund investment opportunities to help supplement your retirement income further, you decide to purchase a new car, or you decide to go travelling, ensure that you seek advice from a financial planner before applying for a reverse mortgage.
Unexpected medical bills can be a source of financial distress for many retirees, so it can be helpful to have a source of cash available in case of just such an emergency. Similarly, emergency repairs to your home or car can also be sources of financial difficulty if you don’t have the contingency funds available.
You may choose to use your funds to assist family members with their own goals. Grandchildren may have expensive education costs or they may require assistance with a deposit on a first home.
Be mindful that all loans come with risks so before you apply for an equity release loan, ensure that you understand the risks involved. Fortunately, the risks associated with a reverse mortgage loan have been reduced as new legislation, such as ‘negative equity protection’, protects you from owing more than what your home is worth.
Case study 2: John and Joan
John and Joan decided to retire early when John turned 62 and Joan was 60. They still owed $38,000 on their home mortgage, but they were only making payments of $52 per week. However, John only had $65,000 in superannuation that had been rolled over to an allocated pension. Even their small mortgage payments were eating into their meagre incomes, so when their home plumbing needed major repairs, they simply didn't have the money. They considered selling their home, but they really didn't want to move. Besides, this would have cost them around $13,000 in real estate agent's fees, plus stamp duty on any other property they purchased, which would leave them even less equity available.
Instead, they opted for a reverse mortgage that was enough to cover the major plumbing repairs, some minor home renovations and buy a new car to see them through their retirement.
Do you have a reverse mortgage product guide?
The lender should be able to provide you with a product information statement that outlines:
- How costs are calculated.
- How interest is charged.
- Features of the reverse mortgage product.
- What to consider before taking out a reverse mortgage.
- What support is available.
What are the financial implications of a reverse mortgage?
The lender should be able to estimate the reverse mortgage calculations for you, which should illustrate:
- The impact a reverse equity loan may have on your personal equity over time.
- The effect of interest rates and house price changes.
What is the cooling off period?
Check the terms of the cooling off period to see what the conditions are if you change your mind.
Ask the lender what will happen in the event that you or your spouse passes away. Check to see if you need the lender’s permission to sell, lease or vacate your home or have someone move in with you.Back to top
What is equity?
Equity is the difference between your home's value and the amount owing on it. For example, if your home is valued at $500,000 and you owe $100,000, you have $400,000 in equity. If your property is valued at $500,000 and you've paid off your mortgage so you owe nothing at all on it, then you have $500,000 in available equity.
How much equity can I unlock with a reverse mortgage?
The amount of equity you're able to access will depend on the age of the youngest borrower and the value of your home. The percentage of equity you can access will generally be between 15% and 45%.
Will I need to make monthly repayments?
No. The interest charges will be capitalised onto the loan amount each month for as long as you stay living in the home. The loan will generally be paid off once the property is sold.
How do I receive money from the loan?
You can elect to receive the funds in a single lump sum payment. However, some lenders may give you the option to receive the funds in instalment amounts if you prefer.
Will I still own my own home if I get a reverse mortgage?
Yes. Your name is still on the title and you retain ownership of your home.
Can I stay in my own home for as long as I wish?
Yes. It's completely up to you when you choose to sell your home or move into a care facility.
What happens if I pass away?
In the event that you pass away and you're the last remaining borrower on your reverse mortgage, the bank will simply work with the Executor of your estate to sell the property. Once the balance of the reverse mortgage is repaid, the remaining proceeds of the sale of your home will go to your estate.
What if I sell my home for more than the amount I owe on the reverse mortgage?
If your home sells for an amount that adequately repays the reverse mortgage and you have some left over, this money remains yours.
What if I sell my home for less than the reverse mortgage loan amount?
As of the 18th September 2012 the Government introduced 'negative equity protection', meaning you can't end up owing the lender more than your house is worth. For contracts entered into before this date, there are still options for you. Some lenders out there are willing to extend a 'Negative Equity Guarantee'. This means your loan amount cannot exceed the value of your property, so you won't ever be forced to sell your home. You or your estate also won't be asked to cover any shortfall that may arise in the event that your home is sold for less than the amount owed on your reverse mortgage.
Can I make sure I still leave my family an inheritance?
It is possible to choose a 'Protected Equity Option' with some lenders. This lets you preserve a predetermined amount of equity that can't be accessed for future use as inheritance for your beneficiaries. For example, if you want to protect 20% of your equity for inheritance purposes, your lender will calculate the amount you can borrow to protect this amount.
For example: if your home is worth $500,000, 20% of this amount is $100,000. So the lender will calculate how much you can borrow based on only having $400,000 in equity available.
What is Equity Release?
An equity release loan is a loan that is available to people who are looking to retire. A reverse mortgage is a type of equity release loan, the other being a line of credit loan. The features of the equity release loan are:
- Equity. When you use an equity release loan you will be borrowing against the equity in your home. The equity is the difference between the amount you owe on a home and the value of the home. For example, if you own a house that is worth $400,000 and you owe $100,000 then you will have $300,000 of equity.
- Equity release. The equity release loan simply unlocks the equity that you have built up in your home so you can have a bit more to spend. You will be borrowing against your home and when you sell your home you will pay back the original loan and the equity release loan.
- Who is suited to equity release? The equity release loan is only suited to people who are retiring and would like to free up some money.
What are the risks of equity release?
When you borrow against the equity in your home you will run the risk of developing negative equity. Negative equity is when you owe more than the security is worth. This will occur when the property values fall dramatically while you have little equity.
Is equity release safe?
Considering the risks that are involved with equity release it is important to understand whether equity release is safe. If you are considering an equity release loan then you should know:
- The safety of it. When you apply for an equity release loan you will be developing more debt at a late stage in your life where you will not have the income to pay it off. The only way you will be able to pay off the loan will be through the sale of the house and if that amount doesn't cover it you, or your siblings, will have to pay out the loan.
- What rights you have. Fortunately, there are some laws which have been developed to ensure that people who apply for negative equity loans are protected. If you have a negative equity loan then you will never be forced to move from your home and you will have the freedom to move to another property without incurring any costs. Furthermore, the equity release loans will also guarantee that you will never go into negative equity. If you do the sale of the house will cover whatever debts you will have to pay.
- What you should do before applying. If you are considering getting an equity release loan then you should be sure to get legal and financial advice. This will help you to look at all your options and you will be able to fully understand all the risks that you are taking when you apply for the equity release loan.
How can I ensure my family home remains debt free?
Before taking out a reverse mortgage, you should ask the lender whether they will accept other assets as security. These may include an investment property or a holiday home which can ensure that your family home remains debt-free.
Do I need to provide income verification to qualify for a reverse mortgage?
You do not need to provide income verification, such as payslips or Centrelink statements, in order to qualify for a reverse mortgage. The lenders offering these types of loans don't take your income into account. Instead, they're lending against the equity you have available in your home.
What is the impact on my social security?
Contact the Department of Human Services to find out how a reverse mortgage may affect your pension entitlements. However, it may be possible to structure your reverse mortgage so that it does not reduce the amount of pension income that you receive.
Is legal advice mandatory?
Yes. All lenders require you to obtain independent legal advice so that you understand the risks involved. Once the loan is approved, you’ll need to access the services of a solicitor.
Are reverse mortgages regulated by the government?
Yes. Reverse mortgage products are regulated by the Federal government as part of the National Consumer Credit Protection (NCCP).