Time to read : 4 Minutes
We all know what a mortgage is… it’s the only way most of us are ever able to buy a home of our own. But have you wrapped your head around the possibilities later offered by a mortgage in reverse? As the term suggests a reverse mortgage allows you to get necessary cash out of your property. And it’s a concept that – in a cost of living crisis – could be very appealing. Let’s look at how a reverse mortgage works, starting with the possibilities.
What are the possibilities of a reverse mortgage?
A reverse mortgage allows you to essentially swap a chunk of equity in your home, for cold hard cash.
This can be a lump sum, income stream or combination of the two. Unlike a regular mortgage, though, you don’t make periodic repayments. The interest incurred rolls up month after month and the debt is repaid on the sale of your house. This would usually happen after you die and would come out of your estate.
Reverse mortgages appeal to older Australians who have paid off, or are close to paying off their properties and there are products available to 55s and over.
How much you can borrow is determined by your age and value of your property. This increases with each year.
For example:
At 55, you may only be able to borrow 15% value of your home.
This increases by 1% each year, so at 65, you may be able to borrow 25%.
Note: the minimum amount you can borrow varies, but it may typically be $50,000.
So, what are the pitfalls of a reverse mortgage?
For more than a decade now, Australian reverse mortgages have carried a no-negative-equity guarantee.
That means you can’t lose your house and your loan can’t grow to more than its value. Previously, it was possible for the size of the loan to outgrow the value of your home… and then potentially face eviction.
Also, as opposed to a reverse mortgage just eroding the money you leave in your will, back then could have also left your heirs with a bill.
But this no longer happens. Your house is safe and your debt will never grow beyond its value.
Be aware: the interest rates (and maybe fees) on reverse mortgages are higher than regular mortgages – that’s logical when you don’t make any repayments and your lender does not know when it will get its money back.
The key here is the level of interest versus the growth in the property market – the lender or broker must provide you with projections of both.
Think of it this way: if the property market outpaces the interest rate, then you will still have some equity in your home.
But if growth in the property market is soft, or prices go backwards, at higher interest rates, any residual amount may not survive. Your intentions regarding the kids’ inheritance are important. You may have a spending the kids’ inheritance (SKI) policy and living it up with any money you can access, after a lifetime of accruing it.
What other crucial things should you know about a reverse mortgage?
Not all homes are eligible for a reverse mortgage
Given the potentially long lifespan of these repayment-‘free’ loans means there are some pretty strict qualification criteria.
While many lenders may want you to have paid off most of your property, it is still possible to have a loan against the property and have it refinanced to a reverse mortgage.
The lender may prefer you to have a house rather than a unit as land size might matter.
The property needs to be in good repair… and you will be obligated to keep it that way, to protect the lender’s investment.
Tips on how to come out on top with a reverse mortgage:
Try to wait as long as you can before taking one out. The less time that the interest rolls up, the less value it will eat up into your home.
Where a couple lives in the home, take out the loan on a last-to-die basis, to prevent the longer-surviving spouse from potentially being kicked out.
Check if you’re allowed to go on extended overseas holidays and be away from the property or whether – if relevant down the track – you could rent it out. Not all lenders allow this.
Consider protecting a portion of your equity guarantee so that it will always be preserved, if a lender offers this feature.
Keep up with the loan condition of maintenance… so that there is no reason for the lender to call in your loan early.
What about the home equity access scheme as an alternative?
It's worth noting that Services Australia offers a form of a reverse mortgage. It's known as the Home Equity Access Scheme. The amount of equity you can access is far less than a commercial reverse mortgage – however, as you probably guessed, it is also at a far lower interest rate. That means your initial loan against your home will grow much more slowly, preserving more of its value for you or your heirs.
Bottom line
Ultimately, a reverse mortgage is an expensive but effective way of tapping into what could be considerable equity in your family home, and to once again afford a lifestyle that is enjoyable. And – whether or not your heirs like it – it’s important for you to enjoy your golden years.
Go deeper:
How do Reverse Mortgages Work?
Financial Disclaimer
The information contained on this web page is of general nature only and has been prepared without taking into consideration your objectives, needs and financial situation. You should check with a financial professional before making any decisions. Any opinions expressed within an article are those of the author and do not specifically reflect the views of Compare Club Australia Pty Ltd.
