Reverse mortgages: What are they?

If you’re an older Australian who owns their own home, you might have heard about using a reverse mortgage as a way to borrow money using the equity you’ve built up in your home.

To help you get to grips with the concept of a reverse mortgage or equity release, this guide will help explain what a reverse mortgage is, how they work, as well as some of the benefits and drawbacks involved. 

A reverse mortgage is a loan, using property as security, which allows older homeowners to make use of the equity in their homes in exchange for a lump sum, ongoing payment or line of credit.

According to regulator ASIC's last review into the reverse mortgage market in 2018, reverse mortgages have gained in popularity. Reverse Mortgage Loan books from banks doubled from $1.3 billion to $2.5 billion between 2008 and 2017. 

This is perhaps unsurprising when you consider the rise in property values over the years and the considerable equity that has built up as a result for homeowners. Equity has become a valuable asset for many homeowners, but unlocking it without selling the actual property isn’t an easy task. 

That’s why reverse mortgages have become a useful option for older homeowners and retirees who want access to a readily usable source of funds, but don’t want to sell up or entirely relinquish ownership of their homes. 

As outlined above, a reverse mortgage is essentially a form of loan that can be taken out by homeowners (typically aged 60 or older) using their own homes as security. These funds can then be used for a whole range of purposes: from day-to-day expenses to larger purchases.

Unlike a traditional home loan where you’re required to make ongoing repayments, a reverse mortgage allows borrowers to continue living in their own homes without making any repayments. Instead, the outstanding balance will be due either when the property is sold, vacated or when the borrower passes away.

Of course, there are costs involved:

• Interest: Reverse mortgage rates are typically higher than home loan interest rates (around 2% higher according to ASIC). It’s also worth noting that because there are no repayments, interest will compound at a faster rate than a typical loan - especially for lump sum payments. 

• Fees: Depending on the lender the type and size of fees will vary, but establishment fees, ongoing service fees and valuation fees are all common. 

The amount of money that you’ll be able to borrow via a reverse mortgage will depend on several factors.  Each lender will have a minimum and maximum loan threshold. A number of factors that will go into determining your borrowing ability including:

• your age
• the value of the property
• the way the funds are received (lump sum, regular payment etc.) and,
• the period over which the loan is taken. 

To get a better idea of your borrowing ability and the impact a loan will have on your equity over time, ASIC Moneysmart's website has a free reverse mortgage calculator.

Like any loan, a reverse mortgage isn't going to suit everyone. Because of the amount of money involved, and the fact that borrowers will be providing their own homes as security, it’s worth thinking carefully before taking one out and seeking independent financial advice before entering into a loan agreement. Here are some points to weigh up:

Reverse mortgage benefits

• You’ll still own and be able to live in your own home
• Most lenders give the flexibility of choice between borrowing a lump sum, opting for regular instalments or even taking it in the form of a line of credit
• You won’t need to worry about making any ongoing repayments

Drawbacks of reverse mortgages 

• Reverse mortgages aren’t available to everyone - you need to own your own home and be over the age of 60 or 65 depending on the lender
• If you’re not making regular repayments, the interest on the outstanding balance plus any fees involved may compound significantly over time
• As your outstanding balance grows, the equity in your property will decrease over time