What is a reverse mortgage and why would you need one?

What is a reverse mortgage and why would you need one?

As the cost of living continues to rise in Australia, many older homeowners are finding themselves in need of additional financial resources to maintain their quality of life into retirement. This is where reverse mortgages can offer a valuable solution.

What is a reverse mortgage?

A reverse mortgage is a type of loan available to homeowners aged 60 and over. A reverse mortgage leverages the equity in your home to access extra cash. A reverse mortgage simply allows you to release the equity in your home to use these funds to live a more comfortable retirement, without having to downsize from the home you love. This money is used for a retiree’s additional living expenses, including paying bills, expenses, food, car expenses, home improvements and repairs, and holidays.

This type of loan is given as a lump sum, an income stream, or a line of credit, with which the borrower does not make monthly repayments towards while they are still living in the home. Rather, the interest continues to be charged on the sum, but the loan, along with the accumulated interest, is typically repaid when the homeowner sells the property, moves into an aged care facility, or passes away.

Who pays the loan amount?

Reverse mortgages are repaid through the sale of the property. This means that there may be less equity remaining to pass onto the homeowner’s family.

There is interest charged on the reverse mortgage, just like any other mortgage. This also compounds over the term of the loan, meaning the balance of the loan continues to increase as the interest builds up. This is in addition to any fees and charges associated with the loan.

What are the pros and cons of reverse mortgages?

If you are considering a reverse mortgage, it’s fundamental to weigh up the pros and cons of them, and how they could affect you and your family’s financial situation. Reverse mortgages tap into an important source of wealth, your home. Below we have explained the pros and cons of a reverse mortgage.

Pros of Reverse Mortgages

A reverse mortgage may offer several potential benefits for homeowners seeking more financial flexibility or stability in their retirement years.

1) Access to Equity

Firstly, a reverse mortgage provides homeowners with a way to access the equity they’ve built up in their homes, providing additional funds during retirement without having to sell their home. As a result, retirees have financial flexibility and can pay for any unexpected expenses related to healthcare, lifestyle choices or even modifications to the home. This financial flexibility allows a retiree to maintain a comfortable lifestyle without the need to downsize from their home.  

2) No Timed Repayments

Secondly, unlike traditional mortgages, reverse mortgages typically don’t require timed repayments, such as monthly repayments. The loan, along with accumulated interest, is repaid when the borrower no longer lives in the home, has transitioned to aged care, or passes away. This can help alleviate the financial strain for some retirees with limited cash flow.

3) Consumer Credit Regulated

Finally, reverse mortgages are the only type of equity release product that are subject to consumer credit regulations in Australia. Reverse mortgages are regulated as credit products under the National Credit Act. These regulations are designed to protect borrowers, ensuring that the reverse mortgage product they receive is beneficial, fair, and transparent. These regulations also set boundaries on the amount that can be borrowed, proportionate to age. This prevents excessive borrowing and helps borrowers maintain a manageable debt level.

Cons of Reverse Mortgages

1) Reduces Your Home Equity

Firstly, a reverse mortgage reduces the percentage of equity that is left in your home, meaning that it you were hoping to pass on your property to your family once you pass away, this will be impacted. Because the loan accrues interest over time, reverse mortgages reduce the value of your estate, and the debt is paid out of any money that would be passed on as inheritance to family.

Using an example, let’s say you are 65 years of age, and the value of your home is $500,000, and you take out a loan amount of $125,000 (25% of the current house value). Rather than receiving a lump sum, you choose to receive regular payments of $25,000 each year for 5 years. In 15 years’ time (when you are 80 years of age), your home value increases to $778,984. Your interest owing is roughly $157,814, meaning the total owing amount is $282,814. Therefore, your home equity is $496,169, which means you have 64% of your home’s equity remaining which is actually higher than what was there when you took the reverse mortgage out initially.

These figures are sourced from a government website, Money Smart, using their Reverse Mortgage Calculator. The below images outline the above figures in more detail.

Alternatively, if you chose to receive a lump sum of $125,000, in 15 years’ time, your home value still increases to $778,984. However, your interest owing is $231,118, and your total owing amount is $356,118. Your home equity is then $422,865, which means you have 54% of your home’s equity remaining. Therefore, it is more beneficial to take out regular payments, to maintain the equity in your home longer, and reduce the interest owing.

These figures were also sourced from Money Smart.

Additionally, the above calculations are based on Money Smart’s projected annual change in property value of 3%. However, based on dwelling values over the past 30 years, CoreLogic projects a 5.4% annual change in property values. Based on the amount of 5.4%, in 15 years’ time your home value increases to $1,100,472. Taking regular repayments rather than a single lump sum, your interest owing is still roughly $157,814, and the total owing amount is still $282,814. Therefore, you will own 74% of your home equity, valued at $817,658.

2) Interest Compounds

Secondly, the interest compounds, so it essentially works against you. This means that in addition to the balance that you borrow, you will have to pay interest on the interest, as well as the fees or charges that are applied to the loan. Interest rates may also be higher than for a standard mortgage loan. As a result, the amount you owe the lender will increase significantly over time.

The debt that is accumulated from reverse mortgages can become faster over time, particularly in this current economic landscape where we are faced with interest rate uncertainty.

No Negative Equity Guarantee (NNEG)

What happens if your loan grows larger than what your home is worth? That’s where No Negative Equity Guarantee (NNEG) comes in. Simply put, NNEG protects you from owing more on your reverse mortgage than your home is worth (market value or equity), meaning a limit is put on the amount owed.

NNEG benefits you in a number of ways:

  • It provides you peace of mind knowing that your financial future, and that of your estate, is more predictable and secure.
  • Your debt is limited, even if the total loan amount, including accrued interest, exceeds the property’s value.
  • With a clearer understanding of the maximum debt limit, you are able to plan your finances and retirement more effectively, without having to worry about debt.
  • Your family can rest assured that your estate won’t be burdened with a debt greater than the value of your home.

Vision can help you with reverse mortgages!

If you would like to learn more about how a reverse mortgage could offer you financial flexibility in your retirement years, reach out to us today. Vision can help you understand your home equity, evaluate the pros and cons, and determine the impact on your inheritance. We don’t just help you get a loan; we will spend the time with you so that you gain an in-depth understanding of your future, gain clarity on whether a reverse mortgage aligns with your financial goals, and explore any other options before making a decision. Whatever you want to achieve, we will get you across the line. Reach out to Vision today and see how we can help.