As elderly loved ones age, they may find living independently a little more challenging. And although there are many pros and cons of retirement village living, they may want to stay in their home as long as possible. But with the cost of living increasing, some over 60s are accessing money by releasing equity from their home.
What is equity?
Equity is the value of your loved one’s home, less any money they owe on their mortgage. “Home equity release” lets them access some of that equity while they continue to live there. One of the ways equity can be accessed is via a reverse mortgage.
However, it’s important to note that there is risk involved and possible long-term financial impacts, so they should get independent legal or financial advice before proceeding. Here we look at how reverse mortgages for seniors work in Australia and some of the pros and cons, including the cost.
What is a reverse mortgage?
In terms of what is a reverse mortgage, essentially, it allows your loved one to take out a loan using the equity in their home as security. However, unlike a standard home loan, instead of the borrower making payments to the lender, the lender makes payments to the borrower. In return, the lender receives equity in the property.
According to Moneysmart, at 60, the most a lender may allow them to borrow is around 15 to 20 percent of the value of their home. However, if they make regular principal and interest payments on their existing home loan (if they have one) and the value of their property increases over time, this percentage will generally become higher the older they get before taking out a reverse mortgage.
Adding one per cent for each year over 60, at 65, the most they can borrow is around 20 to 25 per cent. The minimum amount they can borrow varies, but is typically around $10,000.
How does a reverse mortgage work in Australia?
So how does a reverse mortgage work in Australia? Depending on their age and their lender policy, they can take the amount they borrow as a:
- Regular income stream
- Line of credit
- Lump sum, or
- A combination of these.
They can stay in their home and don’t have to make repayments while living there. They are charged interest on the loan over time, so it increases and adds to the amount they borrow. The interest rate is likely to be higher than on a standard home loan. The loan must be repaid in full (including interest and fees) when they or their deceased estate sells the home. However, they can make voluntary payments earlier.
What should be considered before taking out a reverse mortgage?
Reverse mortgages are generally suited to asset-rich, cash-poor individuals. So, for example, if money is needed for medical purposes and cash is minimal, a reverse mortgage could be worth considering.
However, before taking out a reverse mortgage, your loved ones should understand the impacts it could have on their retirement and their financial future. That’s why it’s essential your loved ones seek independent financial and legal advice before going ahead. Before committing to a particular home loan or lender, they should also read the Target Market Determination (TMD), key information statements and other applicable product documentation they provide.
Moneysmart warns that a reverse mortgage can impact a range of things, including:
- Their eligibility for the Age Pension, in particular, their eligibility for Centrelink payments.
- Their ability to pay for future expenses.
- Their capacity to afford aged care.
- The money they leave to loved ones when they pass away.
- Whether or not someone who lives with them can keep staying in the home when they move out or pass away.
What are the pros and cons of a reverse mortgage?
Pros
Some of the pros of a reverse mortgage include:
- Allowing your loved ones to live in their home as long as they choose.
- Your loved ones still retain ownership of their home as long as they don’t breach their contractual obligations.
- The lender pays off their existing home loan (if they have one), so they don’t have to worry about having multiple debts on the same property.
- Stress relief if they have any financial difficulties or cash flow problems due to not working.
- Extra cash flow that could allow them to enjoy their retirement a little more, such as by going on more holidays.
- Giving them the lump sum of money they need to potentially retire a few years earlier.
- Helping them pay for any caring services or medical expenses without needing to repay the money immediately.
- Not owing the lender more than their home is worth at the end of the reverse mortgage due to “negative equity protection” (which applies to reverse mortgages taken out since September 2012).
Cons
Some of the cons of a reverse mortgage include:
- A reduction or diminishment of the equity in their home over time as their debt increases.
- Interest and fees are eventually still payable on a reverse mortgage, and the interest rate they are charged is likely to be higher than on a standard home loan.
- Interest on a reverse mortgage is compounded, and the loan size increases over time, reducing equity when it’s time to sell.
- Not all forms of security may be acceptable.
- Cash held from the reverse mortgage may potentially affect how much they can receive in government benefits.
- Due to compound interest, they or your beneficiaries may receive less than they otherwise would when the property is sold.
- The reverse mortgage must be paid back, particularly if they received their reverse mortgage as a lump sum.
What does a reverse mortgage cost?
The cost of a loan typically depends on:
- How much they borrow.
- How they take the amount you borrow (for example, a lump sum will cost more due to compounding interest).
- The interest rate and fees (for example, loan establishment, valuation and ongoing fees).
- How long they have had the loan.
Fees and charges
The fees and charges associated with reverse mortgages can be higher than those attached to regular mortgages. They may be charged establishment fees, annual or ongoing fees, or discharge fees. These will often be included in the amount owing on the reverse mortgage, meaning they may have to pay extra interest over time.
Compound interest
This is one of the main things they will need to be wary of with a reverse mortgage. Although interest is charged on a reverse mortgage, they won’t need to repay it while living in the home. The loan generally only needs to be repaid when they sell the home, move away or pass away. However, this means that while the principal owing on a traditional mortgage decreases over time as it’s paid off, the amount owing on a reverse mortgage increases continuously over time. Ultimately, this means they could be left with very little equity in their home, and not much money left after the home is sold and the reverse mortgage is paid back.
Who offers a reverse mortgage for seniors?
From 2018 to 2019, the Big Four Banks withdrew their products from the Reverse Mortgage market. This means that the option to secure a NAB reverse mortgage, CBA reverse mortgage, Westpac reverse mortgage or ANZ reverse mortgage is no longer available.
However, this created the opportunity for new non-bank reverse mortgage lenders to enter the market. If your loved ones are interested in seeking a reverse mortgage loan, it’s just a matter of them doing some research. But again, they should seek independent financial and legal advice before going ahead.
Reverse mortgage calculator
A reverse mortgage calculator can also be helpful. They can find one online at the government’s Moneysmart website.
Are there any alternatives if my loved ones need financial assistance?
Yes. Other ways for them to access equity in their home include:
- An equity release agreement.
- A home sale proceeds share (home reversion).
- The Government’s Home Equity Access Scheme (formerly the Pension Loans Scheme).
You can find out more about these here.
Alternatives to reverse mortgages include:
- Refinancing and taking equity out of their home.
- Selling and downsizing, if it enables them to buy their next property outright with no loan while obtaining the extra cash they need.
- Renting out part of their property, but there may be capital gains tax (CGT) implications.
References
- 2022, Reverse mortgage and home equity release, moneysmart.gov.au
- Jacqueline Belesky, 2021, Reverse mortgages, Canstar
- 2022, The history of Reverse Mortgage loans in Australia, Seniors First
- Monique Pueblos, Tyne Tamer, Australia’s cost of living is soaring. Why is everything so expensive?, SBS News