Reverse mortgages: What are they and how do they work?

australian-houses-near-beach

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.

Despite the name, reverse mortgages aren’t quite the opposite of regular home loans - there’s a bit more to them. So to help you get to grips with the concept, this guide will help explain what reverse mortgages actually are, how they work, as well as some of the benefits and drawbacks involved. 

What is a reverse mortgage?

Reverse mortgage meaning: 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, reverse mortgages have become more and more popular over the last decade, with loan books from banks having 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. Equity has become a valuable asset for many homeowners, but unlocking it without selling the actual property isn’t the easiest task. 

That’s why reverse mortgages could be 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 which 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.

How does a reverse mortgage work? 

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. 

What about the amount that you’ll be able to borrow? Each lender will have a minimum and maximum threshold, plus 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 give you a better idea of your borrowing ability and the impact a loan will have on your equity over time, check out the ASIC Moneysmart reverse mortgage calculator.

Which banks and lenders offer reverse mortgages?

In early 2019, both the Commonwealth Bank and Bankwest actually withdrew from the reverse mortgage market, meaning none of Australia’s largest banks are currently offering dedicated reverse mortgage products.

However, there are still a number of banks offering reverse mortgages including G&C Mutual Bank, Heritage Bank, IMB Bank and P&N Bank to name a few, as well as other specialised lenders like Heartland Seniors Finance.

What are the benefits and drawbacks?

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. Here are some points to weigh up:

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

  • Reverse mortgages aren’t available to everyone - you’ll obviously 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, your equity will decrease over time

Common questions about reverse mortgages (FAQs)

Are there age restrictions for reverse mortgages?

Yes. Generally you’ll have to be over the age of 60 to apply for a reverse mortgage, though some lenders have a higher age requirement of 65 and above. 

What about negative equity?

Negative equity would take place in the event that the value of your home (or the property being used to secure the reverse mortgage) fell below the value of the outstanding balance. However, an amendment to the National Credit Code in 2012 means that lenders can no longer allow borrowers to go into negative equity as a result of taking out a reverse mortgage.

Will a reverse mortgage affect my pension?

There’s no simple answer here, but in short, a reverse mortgage could impact your pension. Ultimately it will depend on how much you borrow, what you use the money for and how both of these factors will affect Centrelink’s asset or income tests.

Are there other options available?

If a reverse mortgage doesn’t sound like the right fit, there could be a number of other borrowing options available to you including the pension loan scheme, a home reversion scheme or even a personal loan.

Looking for more information on a home loan topic? Head on over to the Mozo home loan guides hub for a huge range of articles and other resources on everything from buying and selling to refinancing and investing!

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