How reverse mortgages work

• Discover how to release the equity in your home if you’re over 60.
• Find out the difference between a standard home loan and a reverse mortgage.
• Learn about the advantages and disadvantages of a reverse mortgage.

Many older Australians who might need some extra cash to help fund their retirement have heard about reverse mortgages. But what are they and how do they work?

I spent hours researching them, their benefits and disadvantages. So if you are considering a reverse mortgage, here's what you need to know.

What is a reverse mortgage?

A reverse mortgage is a loan where you borrow money secured against the value of your home.

It’s an option for people who have equity (the difference between what you owe on your property and its current market value) locked up in their homes.

The loan can be in the form of a lump sum, a line of credit, a regular income stream, or a combination of all three.

A key difference between a reverse mortgage and a standard home loan is that you don’t have to make any repayments (although you may have the option to do so if you wish). The loan is repaid when your home is sold – when you move out (including into aged care), or you die.

However, it’s worth remembering that the loan will continue to attract interest, and with compound interest, the final repayment can be much more than the original loan sum.

How does it work?

Step 1: See if you are eligible

You will generally have to be at least 60 to qualify for a reverse mortgage, and some lenders insist you be 65 or over. You may also need to have paid off your mortgage in full, depending on the lender.

Step 2: Find out how much you can borrow

If you are 60, the most you can usually borrow is 15-20 per cent of the value of your home. As you get older, the amount you can borrow increases – generally it’s 1 per cent for each year over 60. If you are 65, for example, you should be able to borrow 20-25 per cent of the value of your home.

Step 3: Work out how much your loan is going to cost

Because key factors including interest rates and the amount you draw down are likely to change, you won’t be able to work out exactly what your loan will cost. You will also need to include any fees attached to setting up and continuing to operate the mortgage.

However there are reverse mortgage calculators available online, such as the one provided by ASIC’s Moneysmart, that will give you a good indication of how much you will owe your lender when the time comes for your home to be sold.

Who can qualify for a reverse mortgage?

You will need to be 60 or over and own your own home to take out a reverse mortgage.

Which banks offer them?

Commonwealth and NAB no longer offer reverse mortgage loans, but ANZ and Westpac have similar products they call Equity Manager and Equity Access loans.

Banks offering standard reverse mortgage products for over-60s include IMB Bank, Heritage Bank, G&C Mutual Bank and P&N Bank as well as specialised lenders such as Heartland Finance and Household Capital.

What are the tax implications of a reverse mortgage?

Because the money you borrow against the value of your home is not considered income by the tax office, you won’t pay tax on your reverse mortgage income or withdrawals.

You will have to continue to pay any property rates and taxes while you remain living in your home.

How might a reverse mortgage affect your benefits?

Having a reverse mortgage could affect your government benefits. For example, a lump sum payment could increase your asset balance to the point where you do not qualify for a full age pension.

It’s best to check with Centrelink before you apply for a reverse mortgage.

Alternatives to reverse mortgages

There are a number of alternatives to reverse mortgages that can help you boost your bank balance. These include:

• Downsizing. Selling your home and buying a cheaper property is a straightforward way of freeing up some extra cash.
• Create passive income. Rental income can be created by renting out a spare room to a permanent tenant or via popular short-term rental sites such as Airbnb and Stayz. You could even put a tiny house on your property and rent it out, or convert your garage into a habitable room.
• Pensions Loans Scheme. Another alternative to a reverse mortgage is the Pension Loans Scheme. Under the scheme, the Federal Government loans you money each fortnight through Centrelink. The loan isn’t taxed but comes with costs and interest payments. To be eligible for the Pensions Loans Scheme, you or your partner must be 66 or over (current age pension qualifying age), able to get a pension and own real estate you can use as security for the loan.

Pros & cons

Case study

Peter, 67, and Jenny, 66, are funding their retirement with superannuation and a partial age pension from Centrelink. They have repaid their mortgage in full and so own their house outright. Although they have enough to live on, they would like to buy a newer car and a caravan to enable them to take a trip around Australia.

They decide to apply for a reverse mortgage. Both of their children are in reasonable financial circumstances, so they are not concerned about depleting their eventual inheritance. Following their application to a specialist reverse mortgage lender, they are invited to meet a broker for discussion and advice.

During the meeting, the broker explains that they can borrow up to 21% of their home’s value at an interest rate of 5.02% p.a., following a professional valuation to establish how much it is currently worth. He also itemises the fees they will have to pay – $2,100 to cover the application fee, stamp duty and brokerage.

Using a reverse mortgage calculator, the broker demonstrates the effect on their desired loan amount – an $80,000 lump sum – of compound interest over 20 years (a stage at which they may need to fund aged care), assuming a 3% annual increase in their property value.

Peter and Jenny are reassured to find that, based on their estimate of their home’s value at $640,000, they would still have an 81% equity in their home in 20 years’ time (resulting in a property value increase to around $1,160,000 and a loan amount by then totalling about $225,000 if they make no repayments).

However, the broker then uses the same calculator to show what could happen if the variable interest rate rose to 7.02%.

In this case their home equity would fall to 57%, at $661,000. They are alarmed by the fact that this may not be enough to cover the lump sum entry cost of aged care for both of them. When they make enquiries at Centrelink they also find out that they may lose their partial age pension and attached benefits if they add as much as $80,000 to their total assets other than their home.

As a result, they change their plan to an upfront lump sum of $40,000 plus a regular payment of $300 per month. The calculator tells them that after 20 years their home equity will be around $917,000 if interest rates don’t change, or $828,000 if the interest rate increases to 7.02% p.a. They are comfortable with this, and decide to stick with this plan even though the official valuation of their home turns out to be than they expected at $675,000.

FAQs

Can you lose your home with a reverse mortgage?

Yes, you can.

As the owner of your home, you will need to keep paying rates and maintenance costs and some lenders may rule you in default on the loan if you don’t. Bankruptcy and failure to comply with any terms of the loan agreement may also see the lender rule you in default. They may require you to immediately pay the loan in full, meaning you may lose your home if you can’t repay it.

However, provided the terms of the loan agreement are kept in order, you can’t end up owing more than your house is worth and you can stay in your house until it is sold. The Federal Government made this law effective from September 18, 2012, but If you took out a reverse mortgage before this date you will need to check your contract to see if you are protected.

What happens if you outlive a reverse mortgage?

You don’t have to repay the loan until the last borrower moves out, so you can remain in your home until that time.

Are heirs responsible for a reverse mortgage?

No, they’re not personally responsible. However, when you die, because your reverse mortgage was secured on your home, ther loan must be repaid before ownership can be transferred by a sale or inheritance. Because of negative equity protection legislation (see above), the size of the reverse mortgage can’t be greater than the value of your home.

What happens if you sell a house with a reverse mortgage?

If you sell a house with a reverse mortgage, the first proceeds of the sale will go to paying off the mortgage. You will keep anything left over.

Can I refinance my reverse mortgage?

You can refinance your reverse mortgage but it pays to carefully consider your circumstances. Refinancing can be beneficial if the value of your home increases or interest rates decrease. In refinancing, you would use the proceeds of the new loan to pay off any outstanding balance on your reverse mortgage.