One of the greatest fears for people who are nearing retirement is not having enough money to maintain a reasonable lifestyle. In many cases, this fear may be warranted. Australians enjoy a high standard of living with good health care which means that people are living longer and can spent 20 or 30 years in retirement. Many of today’s retirees are asset rich but cash poor.
The reverse mortgage – which allows you to borrow cash against the value of your home – is aimed specifically at this group. But are reverse mortgages money for nothing or nothing for your money? Here we take a look at how the reverse mortgage works and provide some tips on what you should look out for before entering into one.
How do reverse mortgages work?
Reverse mortgages work by allowing you to borrow cash against the equity you have in your home. They work the opposite way to a traditional home loan. Instead of you making regular payments and the loan amount diminishing over time, a reserve mortgage will usually not require you to make any regular payments and any interest, fees or charges will be applied to the loan, increasing the debt over time. The loan ends when you go into care, sell your home or die. When the loan ends you or your estate must repay what is owing, usually from the proceeds of the sale of the home.
Who is eligible?
You should be eligible for a reverse mortgage if you are over 60 and own your own home, and will usually be able to borrow between 15% – 40% of the value of your home, depending on your age – the older you are, the more you can borrow.
What are the benefits?
The main benefit of a reverse mortgage is that it allows you to tap into the equity in your home. You can access cash as a lump or use the money as a regular stream of income. You don’t need a regular income to qualify for one a reverse mortgage, and in most cases, you will not need to make any regular payments. This type of loan also allows you to remain in your home and retain ownership of it.
What are the disadvantages?
Interest rates on a reverse mortgage are usually higher than average home loan rates. While a 1% difference in interest rates may not seem like much, remember that the interest compounds, so the debt can rise quickly. A loan could double in less than 10 years, just through the force of compound interest.
If the amount of the loan is increasing dramatically, this can then create a risk that the amount of the loan will end up being more than the value of your property and you will have negative equity. There are reverse mortgage products that offer a “no negative equity guarantee”, which basically ensures that if the loan does become more than the value of your home, then you will not have to repay more than the value of your home.
Because of the increasing nature of a reverse mortgage and the uncertainty of how long the loan will last, you cannot be sure how much you will owe at the end. This can create a number of problems. Firstly, if you need to sell your home and move into retirement housing, you may not have enough left after you repay the reverse mortgage to do this. Secondly, you may have very little left in your estate to distribute to your beneficiaries as inheritance.
A reverse mortgage will usually come with a number of conditions, one being that the home is maintained to a standard set by the lender. As you get older, these obligations may become more onerous and difficult for you to meet. If you have a reverse mortgage with a no negative equity guarantee, you may lose this benefit if you are unable to meet these conditions and the lender may be entitled to evict you.
If you are the only owner but live in the home with someone else, if you need to move or die, the other occupant may not be able to stay there.
It is also important to consider that payments received from a reverse mortgage can impact upon your Centrelink entitlements.
Friend or foe?
On the one hand, reverse mortgages can look like a god-send for retirees who are asset rich and cash poor and in need of some extra income to maintain their lifestyle. However, there are risks associated with them, and these risks may become greater the longer you have a reserve mortgage.
Before entering into a reverse mortgage you should obtain independent advice and be sure of exactly what your obligations will be under the loan.