Older borrowers and retirees who want to access more cash to fund their medical expenses, renovations, and change of lifestyle have the option to get a reverse mortgage.
A reverse mortgage is a type of home loan that is specifically designed for pensioners and retirees who are typically 'asset rich' but 'cash poor'.
Also known as a senior's loan or senior's finance, a reverse mortgage is the most popular form of home equity release in Australia. Reverse mortgages allow people over the age of 60 to convert the equity in their property into cash for any purpose.
- How does a reverse mortgage work?
- What are the costs and fees?
- What are the considerations to take when getting a reverse mortgage?
- What are the risks associated with reverse mortgages?
- What to check in the fine print when applying for reverse mortgages?
How does a reverse mortgage work?
A reverse mortgage is a type of equity release product that allows older Australians to borrow money by using the equity in their home as security for the loan. The amount of equity that can be released is generally determined by the borrowers age and value of the property.
The borrower can choose to receive the loan as either a lump sum, a regular income stream, a line of credit, or as a combination of any of these options.
Although interest is charged as with any other loans, you do not have to make repayments while you live in your house – the interest compounds over time and is added to your loan balance.
You remain the owner of your house and can stay in it for as long as you want to. You will only have to repay the loan in full (including interest and fees) when you sell your house, move into an aged care home, or die. However, you can usually make voluntary payments if you wish.
There are generally no income requirements for reverse mortgages, but responsible lending requirements mean not everyone will be eligible for this type of loan.
What are the costs and fees?
As with most loan products in the market, a reverse mortgage entails various fees.
Fees charged by lenders for reverse mortgages
Type of fee
$500 – $995
Ongoing administration fee
$0 – $12
Loan discharge fee
$300 – $400
Application to increase the credit limit
$395 – $950
Application to lease, sub-divide or introduce an easement onto the property
$0 – $500
Source: ASIC 2018
Aside from lender fees, perhaps the biggest cost of reverse mortgages is that as the interest compounds, the debt grows. The longer you have the loan for, the longer the interest compounds and the bigger amount you eventually need to repay.
Interest rates on reverse mortgages are generally a few percentage points higher than a traditional mortgage.
What should you consider before getting a reverse mortgage?
If you are considering getting a reverse mortgage, it is not just the costs that you need to be aware of. You will need to look over some of the aspects of your finances to see if it is right for you.
Here are some considerations you need to take:
- The impact on your pension. It may be best to think long and hard about how this type of loan may affect your pension entitlement. As with any type of loan, a reverse mortgage entails financial responsibility.
- Loan payments. Ask yourself - how would I take the loan? You could take the funds as a lump sum, a regular income stream, or a line of credit. It may be ideal to consider what option may work the best for you. Use our income and expenditure worksheet to have a rough idea where repayments for your loan would fit.
- Your future expenses. Think about your future needs and how you would afford them. Your health and living situation might change in the coming years - or even as early as now. It is important to plan for extra costs you may incur such as medical expenses and aged care. This way you could save an ample amount of money to cover them.
- Independent legal advice. Ask your legal adviser to explain the fine print of the reverse mortgage contract so you will understand the consequences of breaching any terms and conditions.
What are the risks associated with reverse mortgages?
While reverse mortgages would work for most retirees who own a home, there are some risks that needed to be considered, including the following:
- Interest rates and fees are generally higher than standard home loans
- Your debt can rise quickly as a result of the interest compounding over the term of the loan
- It may affect your pension eligibility
- You may not have enough money for aged care or other future needs
- If you are the sole owner of a property and someone is living with you, that person may not be able to stay there when you die
- If you fix your interest rate, the costs to break your agreement can be very high
However, there are some protections and limitations in place to ensure that reverse mortgage borrowers do not fall in a trap and still enjoy the longevity of their finances.
Negative equity protection
For instance, there is a statutory negative equity protection that protects retirees from ending up owing the lender more than their house is worth in either market value or equity.
When the reverse mortgage contract ends and the house is sold, the lender will receive the proceeds of the sale and the borrower cannot be held liable for any debt above this (except in circumstances such as fraud or misrepresentation).
If the house sells for more than the amount owed to the lender, the borrower and their estate will receive the extra funds.
This statutory requirement applies for reverse mortgage contracts lodged after 18 September 2012.
What to check in the fine print when applying for reverse mortgages?
Before you sign a reverse mortgage contract, check the following first:
Reverse mortgage information statement
Your credit provider or assistant provider (such as a broker) must give you a reverse mortgage information sheet that includes details such as:
- How a reverse mortgage works
- How costs are calculated
- What to consider before taking out a reverse mortgage
- Useful contacts for more information
Reverse mortgage projections
A reverse mortgage projection may help determine the long-term impact of the loan to your finances. Your credit provider must go through the calculations with you in person before you take out the loan. These projections will illustrate the effect a reverse mortgage may have on the equity in your house over time and show the potential impact of interest rates and house price movements.
For other calculations that you may need, use our mortgage calculators.
Find out if the lender will accept a holiday home or investment property as security so your family house can remain debt-free, as well as if there are any special arrangements if your house is already mortgaged.
Special terms and conditions
Ask if there are any restrictions on what you can do with the money.
This is a period in which you can get out of a contract, should you change your mind. rules on this period vary between states and territories, but details on this will be included in the contract.
Find out what happens if you need to transfer the loan to another house when you move, as well as if you or your spouse dies. Make sure to check if you will need permission fro the lender to sell, lease, vacate, or renovate your house or have someone move in with you.
If you are the homeowner and someone else lives with you, the other residents may have to move out when the loan becomes repayable. In some cases, reverse mortgage contracts may protect the rights of the other (non-title-holding) residents by allowing them to stay in the house. If you want this option, make sure you discuss it with your lender before getting a reverse mortgage.