The financial gains and warning signs of reverse mortgages
Reverse mortgages are an increasingly popular way to boost the bank balance for those approaching their twilight years.
Aimed primarily at cash-strapped seniors who own their home – or a substantial portion of it – a reverse mortgage operates as it sounds.
The opposite of a standard loan and principal loan, a reverse mortgage allows property owners to borrow against the equity in their home for a more comfortable lifestyle.
Enabling people to live debt-free until the end of their lives, the equity release model is championed by the Retirement Income Review Report, commissioned by the Federal Government and tabled in November 2020.
This recognised that most Australians have the majority of their assets tied up in the family home.
How it works
Borrowers are not required to make repayments or repay the loan in return for an agreed share of the future sale proceeds of their home.
But they can still opt to repay the loan – even if it’s the interest component only – as they may have done in the past.
The amount borrowed will vary according to the lenders’ requirements and the individual property value.
An applicant’s age can also be integral when calculating the loan-to-value ratio (LVR) permitted in a reverse mortgage scenario.
Together with a lump-sum payment or series of regular instalments, homeowners remain the legal owners on the title and retain the right to live in the home or rent or sell whenever they decide.
The funds provided from a reverse mortgage are typically used to cover expenses later in life, such as medical or aged-care requirements, to top up the retirement fund, or simply to leave something for their children and grandchildren.
Fortunately, reverse mortgages are governed by the National Consumer Credit Protection Act to avoid borrowers owing the lender more than the value of the home.
Seek advice before signing
The financial flexibility that a reverse mortgage provides can be overwhelmingly positive, but it’s equally important to be wary of the downsides.
The interest rates charged are usually higher than a standard variable loan and some include ongoing fees that attract compound interest for the entirety of the loan. These may include establishment fees, monthly or annual fees and discharge fees.
In effect, the cumulative total of the fees increases the amount owing as your home equity decreases.
But to offset this, any appreciation in property values belongs to the borrower.
In some cases, heirs cannot inherit the property until the reverse mortgage is settled.
Drawing a lump sum can also affect eligibility for an aged pension, so it pays to read the small print in the terms and conditions, and always seek advice from your licensed financial advisor, before signing on the dotted line.