Being “asset rich but cash poor” is not uncommon for Australians aged 60 and over. They often own their own house but don’t have access to savings or tangible long-term retirement funding to potentially afford aged care, pre-pay a funeral or even just to help them tick things off their bucket list. This is where a reverse mortgage might be a viable way to leverage the equity in an owned home to create an income stream, a line of credit or access a lump sum payment.
Reverse Mortgage as a way to release home equity
‘Equity’ is the value of your home, less any money you owe on it (on your regular ‘forward’ mortgage). ‘Home equity release’ allows you to access some of your equity, while you continue to live in your home, to spend on the things you need.
A reverse mortgage is one of the ways to access the equity in your home, by allowing you to borrow money using this equity as security. The amount you can borrow usually depends on your age and the value of your home.
How does it work?
Generally, the older you are, the more you can borrow as a percentage of your property’s value. Where there are joint borrowers, the age of the youngest person will determine eligibility. As a guide, you could expect to borrow 15-20% of the value of your house at age 60, and 1% more per year after 60. That means about a maximum of 25-30% at age 70 and 35-40% at 80 years old.
Unlike a standard home loan, reverse mortgages do not require regular repayments. Instead, the lender makes payments to the homeowner, which can be taken as a lump sum, regular income stream, a line of credit or a combination of these options. The homeowner can keep doing just that - owning the home, living in it and benefitting from growth in the home’s value - while the interest charged on the loan compounds over time. This increases the balance of the loan, unless voluntary interest or loan repayments are made. So, even though you won’t have to repay the loan as long as you’re in the house, interest is still compounding during this period, adding to the amount borrowed. The interest rate is likely to be higher than on a standard home loan.
How is a Reverse Mortgage repaid?
While the homeowner won’t need to make repayments while still living in the home, their debt will increase as the home equity decreases over the life of the loan. The reverse mortgage loan balance will need to be repaid in full (including interest and any ongoing fees) when the property used to secure the loan is sold by the owner, or sold by the owner’s estate after their passing. The reverse mortgage will be repaid from the proceeds of the sale or the estate.
What are some pros and cons?
A reverse mortgage can be a useful financial tool to help you access the savings in your home to enhance your lifestyle and wellbeing in retirement without needing to sell your home, but it may also affect eligibility to access other funds such as an aged pension.
As with any important decision, there are pros and cons to consider in tandem with your personal circumstances:
Pros of a Reverse Mortgage
- Allows you to enjoy the comforts of your family home for as long as you wish
- Improves your available retirement funding
- Can aid in establishing a contingency fund
- Provides flexibility to provide income and lump sum payments
- Allows you to remain the owner of your home, benefitting from its capital growth
- No repayments required, leaving more cash available for meeting lifestyle objectives
- Highly regulated in Australia with strong consumer protections in place
Cons of a Reverse Mortgage
- Interest is capitalised, meaning that the value of the loan will increase over time (unless interest is paid over the course of the loan)
- Reduces the amount of your home equity available as a bequest when you die
- Age dictates the Loan to Value Ratio for a reverse mortgage, and these are generally lower compared to standard home loans
- Tend to have slightly higher interest rates than a regular mortgage because loans are generally repaid at the end of the term
- Drawing funds from your property now may reduce what you could potentially access at a later date
It is worth keeping in mind that reverse mortgages tap into an important source of wealth (your home), so you need to carefully weigh up the pros and cons and consider your current and future circumstances. It is also worth thinking about anyone who lives with you and what their position will be if you pass away, considering your home is often your biggest asset to be left to others.
Disclaimer: The content of this blog is intended to provide a general guide to the subject matter. This blog should not be relied upon as legal, financial, accounting or tax advice.