Is home equity release the right option for you?

A 2021 report by consulting firm EY indicated that almost 90 per cent of retirees want to remain in their homes as long as possible. However, many of them don't have the funds to do so. As a result, many retirees turn to a reverse mortgage or a home equity release loan to help them get the money to fund a more comfortable retirement.

A reverse mortgage is also called a home equity release loan or a lifetime mortgage. It’s a loan that lets you unlock some of the money you’ve paid onto your mortgage, as well as any increase in value of your property, to financially support your retirement. To access this type of loan, you need to be 60 years or older. You must also own your home outright, which means you shouldn't have any remaining mortgage owing on it.

There are multiple ways you can access funds using a reverse mortgage. Typically you can choose between getting the funds as a lump sum or setting up regular payments that work as an income stream to help support your retirement. However, unlike a traditional home loan, where you're required to make regular repayments, you don't have to pay anything back onto the reverse mortgage while living in your home. 

Instead, the outstanding loan balance, including the interest and fees, is paid from the sale proceeds of the property after you vacate the home or die. Some lenders, however, offer you the option to make voluntary repayments into your reverse mortgage to protect a portion of your home equity and use it for other purposes.

Overall, an equity release mortgage or reverse mortgage might appear as a great or easy option to fund your retirement, especially if you find yourself cash-strapped but asset-rich. However, there are certain risks involved with reverse mortgages that you should be aware of. 

Firstly, even though you don’t have to make repayments on the loan while living in the home, a reverse mortgage isn't free of all costs. Just because you’re not making repayments doesn’t mean you’re not being charged interest on the money you’ve withdrawn. Plus, reverse mortgage interest rates are typically higher than what you'll pay on a traditional home loan. Since you’re not making any repayments, the interest will compound at a faster rate, eroding your equity faster. When this happens, you'll find you're restricted in using your equity for any other purpose. You may want to go guarantor for one of your kid’s home loans to help them get into the market or renovate your home to help make your living arrangement easier, which will be made difficult if your equity is being eaten by compounding interest.

The other concern with this continued compounding interest while not making repayments is moving into negative equity, where you owe more money on the property than it’s currently worth. This is less of a concern if you’ve taken out a reverse mortgage after September 2012. In 2012 the government added the Enhancements Bill to the National Consumer Credit Protection Act, which made it mandatory for lenders offering reverse mortgages to also offer negative equity protection. It means you cannot end up owing the lender more than what your home is worth.

When the lender sells the property, they cannot hold you (or your estate) responsible for any debt, regardless of the sale price. If your house sells for more than the amount owed to the lender, you (or your estate) are entitled to receive the extra funds. However, if you took out your home equity release loan before 18 September 2012, it's worth checking with your lender about negative equity protection.

If your property doesn’t sell for more than you owe your lender on your reverse mortgage, you or your estate won’t receive any amount from the sale. If this sale happens after you’ve died, your heirs will miss out on any prospective inheritance. Whenever your property is sold, the majority of the sale proceeds will end up going to pay off the equity release mortgage or reverse mortgage. This will only leave a fraction of the value for you to pay for aged care, medical treatments and any other lifestyle requirements you may need at this stage of your life.

Using a reverse mortgage may also affect your ability to access the age pension. Therefore, it's important to seek independent legal and financial advice before deciding to apply for a reverse mortgage as a way of getting more income from your home equity. Your lender is legally required to provide you with a reverse mortgage information statement before finalising the loan. You must take your time to read this document carefully. If you’re using a mortgage broker, you can ask them to break down the information for you in simpler terms so you can better understand the conditions of your loan. Or you can seek independent legal and financial advice to ensure it’s the right choice for you.

Besides a reverse equity loan, there are two other equity release products available to homeowners in Australia. These are home reversions and equity release agreements, and neither of these products can be categorised as a loan.

With a home reversion, you can sell a share of the future value of your home for a lump sum while continuing to live there. The home reversion scheme provider will then own a share of your property. When the property is eventually sold, the home reversion scheme provider receives a payment that is equal to the percentage share they purchased when offering you the lump sum.

You might prefer a home reversion because it doesn't create debt, and you don’t need to sell your home if you're moving into residential aged care. However, there is the fact you’re no longer the sole owner of your property. This also means you lose out on any future value growth of your property for the portion of equity sold under the reversion contract. 

Another option could be an equity release agreement which allows you to sell a portion of your home's value in return for a lump sum or instalment payments. You can continue living in your home, and all you need to do is pay fees for the portion you've sold – somewhat like paying rent on it. However, this payment is deducted from the equity you still hold in your home. This means the remaining equity you have in your home continues to fall as you’re paying this fee. This can make an equity release agreement a risky proposition for most homeowners. 

ASIC also warns against lenders who offer you an income stream in return for the capital growth on your property. In many cases, such agreements will see you receiving much smaller repayments than the other party's capital appreciation. Your contract will also not likely be covered by financial legislation, and you'll not be protected under basic customer protection laws.