A reverse mortgage is a loan that allows you to borrow money using the equity in your home as security.
It’s essentially the opposite of a traditional home loan, as the longer you have it, the bigger it gets. And so it’s generally only used by senior citizens approaching retirement who require funds for an immediate expense and have most of their wealth tied up in their home.
It’s a helpful financial product when used correctly. But there’s a high risk of decimating the equity that you have spent a lifetime building up, and so you need to properly understand how the product functions before signing on the dotted line.
Here’s what you need to know.
How does a reverse mortgage work?
Reverse mortgages let you swap the equity you’ve built in your home for cash. Lenders conduct a valuation of your property and use this valuation, as well as the age of the youngest borrower, to determine how much money you can borrow.
Like any other loan, interest is charged on a reverse mortgage, but you don’t have to make repayments while you live in your home. Consequently, interest rates on reverse mortgages tend to be 1-2% higher than standard home loan rates.
The interest compounds over time and is added to your loan balance, which means your debt will grow at an increasingly rapid rate. You retain ownership of the property, but must repay the loan amount in full when you sell your home, die, or in most cases, move into aged care. And you can choose to take the loan as a lump sum, regular income stream, line of credit, or a combination of the three.
As reverse mortgages are aimed at senior citizens, there’s fortunately plenty of legislation to protect the rights of borrowers.
For example, statutory negative equity protection introduced in 2012 means that you cannot borrow so much that you end up owing the lender more than the market value of your home. And this legislation also states that your estate cannot inherit a debt when you die.
Finally, your credit provider must give you a “reverse mortgage information statement” before any contracts are signed, according to ASIC.
How much will a reverse mortgage cost?
The cost of your reverse mortgage depends on your interest rate, the size of your mortgage, and any fees charged by the lender.
Most lenders will charge an upfront establishment fee between $1500 and $2000, in addition to discharge and ongoing administrative fees (typically up to $15 per month).
However, it’s important to note that most lenders will capitalise these costs into the amount owing on the mortgage, which means that you could end up paying significantly more to switch over to a reverse mortgage than the advertised establishment fee.
And, as mentioned earlier, reverse mortgage rates tend to be between 1 and 2% higher than standard home loan rates.
Who do reverse mortgages suit?
Usually retirees or people about to retire are ideal applicants.
“A person who retires with a great deal of asset-based wealth, particularly their home, but little cash will have difficulty financing any lifestyle,” says mortgage broker Aaron Sainsbury from Smartline.
“These loans are used to convert the value of the home into ready cash, which the borrower can use to fund their retirement lifestyle.”
Darnbrough agrees reverse mortgage products “tend to best suit seniors who are looking for money to supplement their pension or any income they may be making in retirement”.
Generally, this type of loan is only available to homeowners above 60 years of age – though some banks prefer to lend to those over 65.
“To be eligible for a reverse mortgage, the seniors need to own their property although it isn’t usually a problem if there is still a small balance remaining on the original home loan,” Darnbrough says.
The older you are, the more you can borrow. Most banks limit loans to 60-year-olds to 15-20% of the property’s value, but increase this upper limit at a rate of 1% per extra year of age.
Factors to consider before switching to a reverse mortgage
Reverse mortgages allow senior citizens to cash in on the equity they’ve built in their home, to make life a little easier when their income starts to dry up.
Given it typically offers credit at a cheaper rate than the majority of credit cards and loans, it’s often a good way of borrowing money to cover an immediate expense, or to improve your quality of life if you expect to sell the property in the near future.
However, as the interest rates are much higher, your debt levels will rise fairly quickly, and so it’s not typically seen as a long-term solution. Which is partly why it’s only available to senior citizens approaching retirement.
- Debt is capped at the value of your home.
- Helps mortgage-free/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 off the loan.
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- Higher interest rates apply.
- Interest starts accumulating from day one.
- If you are the sole owner, any cohabitants may have to vacant when you die.
- The more you borrow now, and the younger you are, the less equity you will have in your home in the future.
- The more equity you give back to the lender, the less you will have to pass on to your family.
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