Reverse mortgages – how they work and when to use

Reverse mortgage

With the value of residential housing skyrocketing into record territory over the past decade, many retirees are finding the reverse mortgage solution attractive as a way to liberate some of the wealth tied up in their home and provide more cash to spend.  Most commonly reverse mortgages are used to provide additional income in retirement, but other popular uses are for home renovations or extensions, updating a car, or debt consolidation.

So what is a reverse mortgage, how do they work, and when should you consider using one?

 

What is a reverse mortgage?

A reverse mortgage is a loan against your home, taken out in later life.  No regular repayments are required, so the loan balance increases over time as the interest cost gets added onto the debt.  The loan is cleared when your house is sold, typically either when you enter Aged Care, or pass away.  You can take lump sums, or a regular drawing, eg $1,000 per month.

 

How do reverse mortgages work?

The amount you can borrow is determined by your age and the value of your home.  So for instance someone aged 65, with a home worth $1million may be able borrow up to $200,000.  But if they were 80 years of age, with the same value home, they may be able borrow up to $350,000.  This is because the lender will likely have to wait longer to get repaid from the 65 year old customer, and so the loan will have more time to grow as the interest gets added onto the debt.

The lender can never force you to sell, they must wait and only get repaid when the sale occurs.  You continue to be the owner of your home, and benefit from any capital growth should it occur.  There are also regulations that prevent the lender from ever claiming a debt greater than the value of your home – so there is no risk of you leaving a debt behind for your family.

Importantly, no loan repayments are required.  The interest just gets added onto the loan and the whole lot is cleared at the end.

 

When should you consider using a reverse mortgage?

Because the interest is added onto the debt amount, the longer you have a reverse mortgage, the bigger the interest cost, and the less equity you will have in your home.  So generally speaking, you would look to use a reverse mortgage only once you’ve used the bulk of your superannuation savings.  Plenty of exceptions to this might exist, for instance where you need a lump sum for some essential home renovations.  But broadly, the later in life you start your reverse mortgage, the less costly it will be.

Reverse mortgages impact on the amount you will leave behind for beneficiaries, and the amount you have available to move into Aged Care later in life.  For people with no beneficiaries, or for whom they have already given ample support during their life, a reverse mortgage could be a great way to free up the wealth they have built up in their home, and prioritise quality of life.

If you are obtaining a reverse mortgage to generate retirement income, consider taking this as a regular drawing, rather than a large lump sum that you then withdraw from the bank as needed.  By having the reverse mortgage pay you out on a regular basis, you are only paying interest on the funds you actually need.

 

Reverse mortgages are a really useful option for home owners later in life.  They are a great solution for those who find themselves asset rich but cash poor.  Often, to solve this dilemma, retirees will downsize there home, selling the family home and buying something smaller.  But for those already in an appropriately sized home, a reverse mortgage offers the ability to stay in the home and community they are familiar with, whilst also having the cash available to enjoy life.

I suspect reverse mortgages will become increasingly common in Australia over the coming decades.

 

You may also find this item from the ASIC Moneysmart website useful:

https://www.moneysmart.gov.au/superannuation-and-retirement/income-sources-in-retirement/home-equity-release/reverse-mortgages

 

Important Information:

This information is of a general nature only and has been prepared without taking into account your particular financial needs, circumstances and objectives. While every effort has been made to ensure the accuracy of the information, it is not guaranteed. You should obtain professional advice before acting on the information contained in this publication.

About the Author

Paul Benson is a Certified Financial Planner with the Financial Planning Association of Australia, and a Self Managed Super Fund Specialist with the Self Managed Superannuation Association. He is also a member of the Responsible Investment Association of Australasia, and the Ethical Advisors Co-op. He is the proud owner of Guidance Financial Services, a boutique financial planning practice based in Essendon, not far from the Melbourne CBD. Guidance currently manages around $100 million in investments on behalf of their clients, providing bespoke financial planning strategies.

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