Almost 80 per cent of older people want to remain in their home as long as possible but may not have the funds to do so. A reverse mortgage could help such asset rich, cash poor retirees fund a more comfortable retirement, but lack of understanding regarding how equity release products work remains a barrier, highlights a recently published survey report covering data from 13 countries, including Australia and New Zealand.
What is a reverse mortgage?
Worried if your savings would be adequate to ensure a smooth retired life? Cashing into your home equity using a reverse mortgage might be an option worth considering.
A reverse mortgage is a home equity release product that allows you to borrow money by using the equity in your house as security. You could take this amount as a lump sum, a regular income stream, or a mix of both.
Most lenders will require you to be 60 years or above to be eligible for a reverse mortgage on your house. The benefit of the loan is that you don’t have to make any repayments while you reside in your home. The interest is compounded and added to the loan balance over time.
The entire balance must be repaid when you move out of the house or die.
How does it work?
Unlike a traditional mortgage, you don’t have to make any ongoing repayments when you take out a reverse mortgage. As no repayments are made while you reside in your home, the interest accumulates and continuously gets added to the total loan amount. Eventually, the lender will sell off the property to clear the debt once you decide to move out of the house or die.
Overall, a reverse mortgage could help you enjoy your retirement by using the equity you’ve built into your home while continuing to stay in it. Most lenders also allow you to choose between a lump sum amount or getting paid in regular instalments to help you come to an arrangement that matches your lifestyle and money requirement.
On the flip side, a reverse mortgage will gradually erode your equity, and it’s possible you won’t be left with anything of your home by the time you decide to move out. Reverse mortgages are also not available to everyone. You need to own your home outright and be at least 60 years of age at the time of applying for a reverse mortgage.
If you think a reverse mortgage product might be suitable for you, consider discussing your plans with a financial advisor, as well as your family members, to avoid any financial traps and emotional arguments.
How much can I borrow with a reverse mortgage?
As a general principle, the older you are, the more you’ll be able to borrow. At 60 years, you can borrow up to 15-20% of the property’s total value. Depending on various lenders, this amount varies and generally increases with age.
Is it all for free?
Well, no. As for most things in life, there is a price to pay – an application fee and an interest rate that might be a few points higher than the market rate.
So, what is the downside of this product?
- Firstly, the emotional value attached to the house, and lesser inheritance for your children.
- There is a chance that a lump sum payout might affect your old-age pension.
- High application fees and higher interest rates.
- Compounding interest can quickly increase your debt.
- Over the years, as your debt increases, the equity in your home will reduce, and you may not have enough money left as you grow older.
Even though a reverse mortgage seems like an easy option to finance your retirement, it’s worth considering the impact of a reverse mortgage on your equity and how it affects your other plans. When you take out a reverse mortgage, you don’t make any repayments while using the house. During this time, the interest on your loan keeps compounding and increases your loan size, leaving you with lesser and lesser equity over time. Eventually, there may come a stage when you end up owing the lender more money than your home’s market value. To prevent such a situation, it’s now mandatory for lenders to provide negative equity protection.
Under the negative equity protection clause, you (or your estate) cannot be held responsible for any amount exceeding the sale proceeds from your house once the reverse mortgage ends. However, if the sale proceeds from the property happen to exceed the outstanding debt, you’re entitled to receive the extra funds.
Work out whether it is a good option for you
Let’s look at the example below.
Joe is a 60-year-old man who owns a $600,000 house and decides to take out a reverse mortgage of $100,000 at an interest rate of 5%.
Using our Reverse Mortgage Calculator, he calculated that he would owe $479,773 after 15 years. The equity in the home would have increased marginally (assumed property growth rate of 3.5% and basic fee included) whereas the mortgage debt would rise to $479,773. As you will see, the debt increases significantly over time and can quickly outgrow the equity in the house. This is where the ‘no negative’ guarantee kicks in to protect the borrower by not allowing the debt to be more than the market price of the house at any point in time.
It’s also up to Joe how he decides to use the money he receives out of the mortgage. He might use it to repay some existing debts, make some home improvements or even pay off the charges for a residential care facility in advance. He could also use the money to travel the world or pursue other interests. However, it helps to be practical about your financial situation and plan for the long haul while deciding what you’re going to do with your money in your golden years.
If you’re considering a reverse mortgage, it’s also worth noting that while negative equity protection prevents you from owing more money than the home’s worth, reduced equity means you might not have enough left to pay for aged care if you decide to move to a senior care facility at a later stage. It’s thus advisable to seek independent legal and financial advice before applying for a reverse mortgage. You may even speak with a mortgage broker to understand the product in detail and how it will impact you in the long run. Here’s a Reverse Mortgage Checklist to get you going.