Using a reverse mortgage to pay for retirement

Using a reverse mortgage to pay for retirement

If you’re one of many cash-poor but asset-rich homeowners in Australia looking to free up some extra funds, a reverse mortgage is one way you can do so. 

The average age of borrowers taking out a reverse mortgage is 75, so many Aussies are turning to reverse mortgages to pay for their retirement.

What is a reverse mortgage? 

A reverse mortgage is when you use the equity in your home as security against a loan that you take out with a lender. It’s one way that asset-rich Aussies can pay for the things they want without having to sell their home.

According to ASIC’s MoneySmart website:

A reverse mortgage is a type of home loan that allows you to borrow money using the equity in your home as security. The loan can be taken as a lump sum, a regular income stream, a line of credit or a combination of these options. 

Interest is charged like any other loan, except you don’t have to make repayments while you live in your home – the interest compounds over time and is added to your loan balance. You remain the owner of your house and can stay in it for as long as you want.

What are the pros and cons of a reverse mortgage? 

This loan type allows you to access extra income that won’t force you to give up your home by selling it outright. Also, as of 18 September 2012, negative equity protection was put in place to prevent borrowers from owing more than their home is worth. You also do not need to make regular payments until you no longer live in your home. 

However, it is important that consumers understand the risks associated with this type of lending. Interest rates are often higher than other home loan products on the market, and compound interest on the loan can make the total amount of debt accumulate quickly. 

While regular payments are not immediately required, you must repay the loan in full when you sell your home or move into aged care or die. Also, taking out a reverse mortgage can affect your pension eligibility, and in some circumstances if you are the sole owner of the property and someone lives with you, they may not be able to stay in the home when you die.

Pros
  • Access equity easily without selling your home
  • Negative equity protection
Cons
  • Higher than average interest rates
  • Compound interest grows debt faster
  • Can impact pension eligibility

 

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Who takes out a reverse mortgage? 

According to a report on reverse mortgages by Deloitte, in 2015 there were 40,000 reverse mortgages with an average loan size of $92,000. It was estimated that more than $500 billion in home equity is held by Australians aged over 65, and reverse mortgage loans make up $3.66 billion as at the end of 2014. 

The Deloitte report also found that most reverse mortgage customers are couples (47 per cent) followed by single females (36 per cent). These customers’ average age is 70-79 (49 per cent) and the average age of new borrowers is 75 years. 

As most home owners have fully paid off their homes and are retired by 75, it makes sense that this would be one option to help fund some of their retirement dreams. However, there are rules around how much you can borrow against your home. 

According to ASIC’s MoneySmart:

As a general guide, if you are 60 the maximum amount you can borrow is likely to be 15-20 per cent of the value of your home. You can usually add 1 per cent for each year older than 60. That means if you are 70, the maximum amount you could borrow would be about 25-30 per cent.

The minimum amount you can borrow may depend on the provider. It could be as low as $10,000. Keep in mind that if you borrow the maximum amount now, you may not have access to any more money later.

Should I use a reverse mortgage to fund my retirement?

A reverse mortgage is one way you can free up some funds for anything from a holiday, to helping your children pay for their first home deposit. It should not be the only thing you use to fund your retirement due to the higher than average home loan fees and the minimum percentage of your home equity you can take a loan against. 

If you’re considering the future and planning on using a reverse mortgage to fund your retirement, you may be better off making regular, extra payments into your superannuation. Many Aussies don’t want to sell their homes to fund their retirement. In this instance, making extra contributions to your superannuation balance before tax (salary sacrificing) and after tax, will ensure you’re covered for the future.

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Learn more about home loans

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.

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.

What is a low-deposit home loan?

A low-deposit home loan is a mortgage where you need to borrow more than 80 per cent of the purchase price – in other words, your deposit is less than 20 per cent of the purchase price.

For example, if you want to buy a $500,000 property, you’ll need a low-deposit home loan if your deposit is less than $100,000 and therefore you need to borrow more than $400,000.

As a general rule, you’ll need to pay LMI (lender’s mortgage insurance) if you take out a low-deposit home loan. You can use this LMI calculator to estimate your LMI payment.

How can I calculate interest on my home loan?

You can calculate the total interest you will pay over the life of your loan by using a mortgage calculator. The calculator will estimate your repayments based on the amount you want to borrow, the interest rate, the length of your loan, whether you are an owner-occupier or an investor and whether you plan to pay ‘principal and interest’ or ‘interest-only’.

If you are buying a new home, the calculator will also help you work out how much you’ll need to pay in stamp duty and other related costs.

How do I take out a low-deposit home loan?

If you want to take out a low-deposit home loan, it might be a good idea to consult a mortgage broker who can give you professional financial advice and organise the mortgage for you.

Another way to take out a low-deposit home loan is to do your own research with a comparison website like RateCity. Once you’ve identified your preferred mortgage, you can apply through RateCity or go direct to the lender.

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.

How can I pay off my home loan faster?

The quickest way to pay off your home loan is to make regular extra contributions in addition to your monthly repayments to pay down the principal as fast as possible. This in turn reduces the amount of interest paid overall and shortens the length of the loan.

Another option may be to increase the frequency of your payments to fortnightly or weekly, rather than monthly, which may then reduce the amount of interest you are charged, depending on how your lender calculates repayments.

Will I have to pay lenders' mortgage insurance twice if I refinance?

If your deposit was less than 20 per cent of your property’s value when you took out your original loan, you may have paid lenders’ mortgage insurance (LMI) to cover the lender against the risk that you may default on your repayments. 

If you refinance to a new home loan, but still don’t have enough deposit and/or equity to provide 20 per cent security, you’ll need to pay for the lender’s LMI a second time. This could potentially add thousands or tens of thousands of dollars in upfront costs to your mortgage, so it’s important to consider whether the financial benefits of refinancing may be worth these costs.

Remaining loan term

The length of time it will take to pay off your current home loan, based on the currently-entered mortgage balance, monthly repayment and interest rate.

How can I get a home loan with bad credit?

If you want to get a home loan with bad credit, you need to convince a lender that your problems are behind you and that you will, indeed, be able to repay a mortgage.

One step you might want to take is to visit a mortgage broker who specialises in bad credit home loans (also known as ‘non-conforming home loans’ or ‘sub-prime home loans’). An experienced broker will know which lenders to approach, and how to plead your case with each of them.

Two points to bear in mind are:

  • Many home loan lenders don’t provide bad credit mortgages
  • Each lender has its own policies, and therefore favours different things

If you’d prefer to directly approach the lender yourself, you’re more likely to find success with smaller non-bank lenders that specialise in bad credit home loans (as opposed to bigger banks that prefer ‘vanilla’ mortgages). That’s because these smaller lenders are more likely to treat you as a unique individual rather than judge you according to a one-size-fits-all policy.

Lenders try to minimise their risk, so if you want to get a home loan with bad credit, you need to do everything you can to convince lenders that you’re safer than your credit history might suggest. If possible, provide paperwork that shows:

  • You have a secure job
  • You have a steady income
  • You’ve been reducing your debts
  • You’ve been increasing your savings

What if I can't pay off my guaranteed home loan?

If you can’t pay off your guaranteed home loan, your lender might chase your guarantor for the money.

A guaranteed home loan is a legally binding agreement in which the guarantor assumes overall responsibility for the mortgage. So if the borrower falls behind on their mortgage, the lender might insist that the guarantor cover the repayments. If the guarantor fails to do so, the lender might seize the guarantor’s security (which is often the family home) so it can recoup its money.

What is a credit limit?

The maximum amount that can be borrowed from a lender, as per the home loan contract.

How much money can I borrow for a home loan?

Tip: You can use RateCity how much can I borrow calculator to get a quick answer.

How much money you can borrow for a home loan will depend on a number of factors including your employment status, your income (and your partner’s income if you are taking out a joint loan), the size of your deposit, your living expenses and any other debt you might hold, including credit cards. 

A good place to start is to work out how much you can afford to make in monthly repayments, factoring in a buffer of at least 2 – 3 per cent to allow for interest rate rises along the way. You’ll also need to factor in additional costs that come with purchasing a property such as stamp duty, legal fees, building inspections, strata or council fees.

If you are planning on renting the property, you can factor in the expected rental income to help offset the mortgage, but again it’s prudent to add a significant buffer to allow for rental management fees, maintenance costs and short periods of no rental income when tenants move out. It’s also wise to factor in changes in personal circumstances – the typical home loan lasts for around 30 years and a lot can happen between now and then.