What is a reverse mortgage, and what are the risks?

What is a reverse mortgage, and what are the risks?

A reverse mortgage is a financial product that allows retirees to unlock the value of their family home. Sometimes called an equity release loan, a reverse mortgage lets you access a lump sum, line of credit or income stream to support your lifestyle in retirement. But just like any other financial product, there are risks involved with reverse mortgages, which you should be aware of before you apply.

Who can get a reverse mortgage?

To be eligible for a reverse mortgage, you typically need to be aged 60 or older, and own your home outright, so your property does not have a mortgage owing on it.

How much can I borrow in a reverse mortgage?

The value of your property will help determine how much money you can borrow against it. According to MoneySmart:

If you're age 60, the most you can borrow is likely to be 15–20% of the value of your home. As a guide, add 1% for each year over 60. So, at 65, the most you can borrow will be about 20–25%. The minimum you can borrow varies, but is typically about $10,000.

You may be able to borrow this money in one lump sum, or draw down from a maximum credit limit, a bit like using a credit card. You may also be able to receive a regular income stream to help your everyday living costs, supplementing the aged pension and superannuation.

How much does a reverse mortgage cost?

Reverse mortgages charge interest at fixed or variable rates that are generally higher than most typical home loans. There may also be other fees and charges to consider.

Unlike many other credit products, a reverse mortgage has no minimum repayments or fixed repayment date – you could theoretically borrow the money and never make a payment. You can still make voluntary repayments to pay down your debt.

But before you get too excited, remember that you’ll still be charged interest on the money you borrow. These interest charges will be capitalised back into the loan, adding their costs to your debt. Compound interest means you’ll  be charged interest on your interest, further increasing the size of your loan.

Because you aren’t required to make minimum repayments on a reverse mortgage, your debt can keep building up until it’s much more than you can easily afford to repay. In the past, reverse mortgage made it possible to end up in negative equity, where your debt grows larger than the value of your home. However, legislation introduced in 2012 now limits the maximum debt of a reverse mortgage to the value of your property.

How long does a reverse mortgage last?

A reverse mortgage can run until you sell your property, move into aged care, or pass away.  The value of your home is then used to repay the outstanding loan in full, including the interest charges and fees.

What are the risks of a reverse mortgage?

The biggest risk of a reverse mortgage is the accumulation of compound interest charges. If you’re not careful, these can quickly add up, until the majority of your home’s value is tied up in the reverse mortgage. This can limit what else you can use your home equity for, such as applying for other credit products, or guaranteeing a relative’s home loan application.

When your home is eventually sold, the more of its value that goes towards servicing your reverse mortgage, the less you can use for other purposes, such as paying for aged care, medical treatments, or just a comfortable retirement lifestyle. Your heirs may also miss out a percentage of their inheritance if the value of your home must cover the cost of your reverse mortgage.

Using a reverse mortgage to access extra income from your home equity may affect your ability to access the age pension. Depending on your superannuation situation, this could make managing your retirement lifestyle more challenging.

While you have a reverse mortgage, your lender will have a financial interest in your home. This could mean you’ll need to consult with the lender before making changes to the property that could affect its value, such as renovating. The lender may also require that you keep your home well-maintained in order to preserve its value, at your own expense.

Where can I get a reverse mortgage?

Several of Australia’s major banks offer reverse mortgages, along with some non-bank lenders.

The Australian Federal Government also has its own reverse mortgage program, in the form of the Pension Loans Scheme.

Before you sign on any dotted lines, it’s important to compare different reverse mortgage options and consider their terms and conditions. Consider contacting a financial adviser for more help working out if a reverse mortgage is the right choice for your financial situation.

Did you find this helpful? Why not share this article?

Advertisement

RateCity

Money Health Newsletter

Subscribe for news, tips and expert opinions to help you make smarter financial decisions

By signing up, you agree to the ratecity.com.au Privacy & Cookies Policy and Terms of Use, Disclaimer & Privacy Policy

Advertisement

Learn more about home loans

What is a line of credit?

A line of credit, also known as a home equity loan, is a type of mortgage that allows you to borrow money using the equity in your property.

Equity is the value of your property, less any outstanding debt against it. For example, if you have a $500,000 property and a $300,000 mortgage against the property, then you have $200,000 equity. This is the portion of the property that you actually own.

This type of loan is a flexible mortgage that allows you to draw on funds when you need them, similar to a credit card.

What are the responsibilities of a mortgage broker?

Mortgage brokers act as the go-between for borrowers looking for a home loan and the lenders offering the loan. They offer personalised advice to help borrowers choose the right home loan for their needs.

In Australia, mortgage brokers are required by law to carry an Australian Credit License (ACL) if they offer credit assistance services. Which is the legal term for guidance regarding the different kinds of credit offered by lenders, including home loan mortgages. They may not need this license if they are working for an aggregator, for instance, as a franchisee. In both these situations, they need to comply with the regulations laid down by the Australian Securities and Investments Commission (ASIC).

These regulations, which are stipulated by Australian legislation, require mortgage brokers to comply with what are called “responsible lending” and “best interest” obligations. Responsible lending obligations mean brokers have to suggest “suitable” home loans. This means loans that you can easily qualify for,  actually meet your needs, and don’t prove unnecessarily challenging for you.

Starting 1 January 2021, mortgage brokers must comply with best interest obligations in addition to responsible lending obligations. These require mortgage brokers to act in the best interest of their customers and also requires them to prioritise their customers’ interests over their own. For instance, a mortgage broker may not recommend a lender who gives them a commission if that lender’s home loan offer does not benefit that particular customer.

What happens to your mortgage when you die?

There is no hard and fast answer to what will happen to your mortgage when you die as it is largely dependent on what you have set out in your mortgage agreement, your will (if you have one), other assets you may have and if you have insurance. If you have co-signed the mortgage with another person that person will become responsible for the remaining debt when you die.

If the mortgage is in your name only the house will be sold by the bank to cover the remaining debt and your nominated air will receive the remaining sum if there is a difference. If there is a turn in the market and the sale of your house won’t cover the remaining debt the case may go to court and the difference may have to be covered by the sale of other assets.  

If you have a life insurance policy your family may be able to use some of the lump sum payment from this to pay down the remaining mortgage debt. Alternatively, your lender may provide some form of mortgage protection that could assist your family in making repayments following your passing.

Which mortgage is the best for me?

The best mortgage to suit your needs will vary depending on your individual circumstances. If you want to be mortgage free as soon as possible, consider taking out a mortgage with a shorter term, such as 25 years as opposed to 30 years, and make the highest possible mortgage repayments. You might also want to consider a loan with an offset facility to help reduce costs. Investors, on the other hand, might have different objectives so the choice of loan will differ.

Whether you decide on a fixed or variable interest rate will depend on your own preference for stability in repayment amounts, and flexibility when it comes to features.

If you do not have a deposit or will not be in a financial position to make large repayments right away you may wish to consider asking a parent to be a guarantor or looking at interest only loans. Again, which one of these options suits you best is reliant on many factors and you should seek professional advice if you are unsure which mortgage will suit you best.

What is mortgage stress?

Mortgage stress is when you don’t have enough income to comfortably meet your monthly mortgage repayments and maintain your lifestyle. Many experts believe that mortgage stress starts when you are spending 30 per cent or more of your pre-tax income on mortgage repayments.

Mortgage stress can lead to people defaulting on their loans which can have serious long term repercussions.

The best way to avoid mortgage stress is to include at least a 2 – 3 per cent buffer in your estimated monthly repayments. If you could still make your monthly repayments comfortably at a rate of up to 8 or 9 per cent then you should be in good position to meet your obligations. If you think that a rate rise would leave you at a risk of defaulting on your loan, consider borrowing less money.

If you do find yourself in mortgage stress, talk to your bank about ways to potentially reduce your mortgage burden. Contacting a financial counsellor can also be a good idea. You can locate a free counselling service in your state by calling the national hotline: 1800 007 007 or visiting www.financialcounsellingaustralia.org.au.

How to break up with your mortgage broker

If you find a mortgage broker giving you generic advice or trying to sell you a competitive offer from an unsuitable lender, you might be better off  breaking up with the mortgage broker and consulting someone else. Breaking up with a mortgage broker can be done over the phone, or via email. You can also raise a complaint, either with the broker’s aggregator or with the Australian Financial Complaints Authority as necessary.

As licensed industry professionals, mortgage brokers have the responsibility of giving you accurate advice so that you know what to expect when you apply for a home loan. You may have approached the mortgage broker, for instance, because you have questions about the terms of a home loan a lender offered you. 

You should remember that mortgage brokers are obliged by law to act in your best interests and as part of complying with The Australian Securities and Investments Commission’s (ASIC) regulations. If you feel you didn’t get the right advice from the mortgage broker, or that you lost money as a result of accepting the broker’s suggestions regarding a lender or home loan offer, you can file a complaint with the ASIC and seek compensation. 

When you first speak to a mortgage broker, consider asking them about their Lender Panel, which is the list of lenders they usually recommend and who may pay them a commission. This information can help you decide if the advice they give you has anything to do with the remuneration they may receive from one or more lenders.

How do I calculate monthly mortgage repayments?

Work out your mortgage repayments using a home loan calculator that takes into account your deposit size, property value and interest rate. This is divided by the loan term you choose (for example, there are 360 months in a 30-year mortgage) to determine the monthly repayments over this time frame.

Over the course of your loan, your monthly repayment amount will be affected by changes to your interest rate, plus any circumstances where you opt to pay interest-only for a period of time, instead of principal and interest.

Do mortgage brokers need a consumer credit license?

In Australia, mortgage brokers are defined by law as being credit service or assistance providers, meaning that they help borrowers connect with lenders. Mortgage brokers may not always need a consumer credit license however if they’re operating solo they will need an Australian Credit License (ACL). Further, they may also need to comply with requirements asking them to mention their license number in full.

Some mortgage brokers can be “credit representatives”, or franchisees of a mortgage aggregator. In this case, if the aggregator has a license, the mortgage broker need not have one. The reasoning for this is that the franchise agreement usually requires mortgage brokers to comply with the laws applicable to the aggregator. If you’re speaking to a mortgage broker, you can ask them if they receive commissions from lenders, which is a good indicator that they need to be licensed. Consider requesting their license details if they don’t give you the details beforehand. 

You should remember that such a license protects you if you’re given incorrect or misleading advice that results in a home loan application rejection or any financial loss. Brokers are regulated by the Australian Securities & Investment Commission (ASIC), as per the National Consumer Credit Protection (NCCP) Act. 

What is equity and home equity?

The percentage of a property effectively ‘owned’ by the borrower, equity is calculated by subtracting the amount currently owing on a mortgage from the property’s current value. As you pay back your mortgage’s principal, your home equity increases. Equity can be affected by changes in market value or improvements to your property.

What are the pros and cons of no-deposit home loans?

It’s no longer possible to get a no-deposit home loan in Australia. In some circumstances, you might be able to take out a mortgage with a 5 per cent deposit – but before you do so, it’s important to weigh up the pros and cons.

The big advantage of borrowing 95 per cent (also known as a 95 per cent home loan) is that you get to buy your property sooner. That may be particularly important if you plan to purchase in a rising market, where prices are increasing faster than you can accumulate savings.

But 95 per cent home loans also have disadvantages. First, the 95 per cent home loan market is relatively small, so you’ll have fewer options to choose from. Second, you’ll probably have to pay LMI (lender’s mortgage insurance). Third, you’ll probably be charged a higher interest rate. Fourth, the more you borrow, the more you’ll ultimately have to pay in interest. Fifth, if your property declines in value, your mortgage might end up being worth more than your home.

What is equity? How can I use equity in my home loan?

Equity refers to the difference between what your property is worth and how much you owe on it. Essentially, it is the amount you have repaid on your home loan to date, although if your property has gone up in value it can sometimes be a lot more.

You can use the equity in your home loan to finance renovations on your existing property or as a deposit on an investment property. It can also be accessed for other investment opportunities or smaller purchases, such as a car or holiday, using a redraw facility.

Once you are over 65 you can even use the equity in your home loan as a source of income by taking out a reverse mortgage. This will let you access the equity in your loan in the form of regular payments which will be paid back to the bank following your death by selling your property. But like all financial products, it’s best to seek professional advice before you sign on the dotted line.

What percentage of income should my mortgage repayments be?

As a general rule, mortgage repayments should be less than 30 per cent of your pre-tax income to avoid falling into mortgage stress. When mortgage repayments exceed this amount it becomes hard to budget for other living expenses and your lifestyle quality may be diminished.

How much can I borrow with a guaranteed home loan?

Some lenders will allow you to borrow 100 per cent of the value of the property with a guaranteed home loan. For that to happen, the lender would have to feel confident in your ability to pay off the mortgage and in the security provided by your guarantor.

Are bad credit home loans dangerous?

Bad credit home loans can be dangerous if the borrower signs up for a loan they’ll struggle to repay. This might occur if the borrower takes out a mortgage at the limit of their financial capacity, especially if they have some combination of a low income, an insecure job and poor savings habits.

Bad credit home loans can also be dangerous if the borrower buys a home in a stagnant or falling market – because if the home has to be sold, they might be left with ‘negative equity’ (where the home is worth less than the mortgage).

That said, bad credit home loans can work out well if the borrower is able to repay the mortgage – for example, if they borrow conservatively, have a decent income, a secure job and good savings habits. Another good sign is if the borrower buys a property in a market that is likely to rise over the long term.