What is a loan to value ratio on a reverse mortgage

A reverse mortgage is one of the common ways for seniors to access their home equity without selling the property. This type of loan may be used to supplement their retirement income, manage expenses, and maintain a good lifestyle after retirement.

If you’re over 60 and considering applying for a reverse mortgage, you’ll want to know how much you can borrow. As with any other loan, there are many parameters to determine your borrowing capacity. These can include your age, property value, loan duration, lender, and the loan-to-value ratio (LVR).

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With a reverse mortgage, you can take out a loan using your home as security. You can receive the loan amount as a lump sum, a regular income stream, a line of credit, or a combination of any of these options.

You may be inclined to opt for this form of borrowing because, unlike a conventional home loan, you don't have to make monthly repayments. However, be aware that the compound interest will continue to be charged on the principal amount. You will have to repay the entire amount, including the interest, when you sell your home or move into aged care, or your benefactors will have to do so when you pass away.

To take out a reverse mortgage, you'll usually need to have 100% equity in the property, meaning you’ve repaid your mortgage in full. Some lenders may allow you to take out a reverse mortgage if you still have a small amount remaining on your home loan, though this may affect how much money you can access from your reverse mortgage.

The amount you can borrow with a reverse mortgage largely depends on two key factors: your age and the value of your property, which is reflected in the loan-to-value ratio (LVR).

Loan-to-value ratio (LVR)

The value of your property is a key factor affecting how much you can borrow. This amount will be a certain percentage of the total value of your home equity. This percentage is known as the LVR.

For a reverse mortgage, it is calculated by dividing the amount you wish to borrow by the total market value of your property. Most lenders in Australia offer an LVR range of 15% to 45%, depending on your age and lender policies.

Examples of LVR against a range of different home and loan values:

Age and borrowing capacity

Your age plays a significant role in determining the LVR available to you. In Australia, only individuals aged 60 or above can apply for a reverse mortgage. Typically, a 60-year-old can borrow 15-20% of their home’s value. As you grow older, your borrowing capacity increases.

For example:

• At age 70, you may be able to borrow 25-30% of your property’s value.
• At age 80, this can rise to 35-40%.

The borrowing capacity grows with age, allowing older borrowers to access a higher proportion of their home’s equity. The minimum borrowing amount typically starts at around $10,000, and the amount you can borrow increases with both your age and the value of your property.

To get a better idea of the amount you can borrow compared to your home equity, you can use the Reverse Mortgage Calculator provided by either Moneysmart or the Australian Securities & Investments Commission (ASIC).

It’s important to understand that you will have to answer a few questions about yourself and your property, including:

• Your age
• Identification details
• The projected annual change in property value

Based on the results you receive, you'll better understand how much you will owe over time and the impact a reverse mortgage can make on your home equity.

A reverse mortgage can help older Australians access their home equity without monthly repayments. But the way the product works can gradually reduce the amount of equity they hold in the property. As no repayments are necessary, compound interest accumulates on the loan balance, causing it to grow over time. This increase in the loan amount results in a smaller share of home equity remaining with the homeowner, leaving less available for inheritance or future needs.

In its 2018 review, the Australian Securities and Investments Commission (ASIC) noted that while many borrowers understood their loan balance would grow, they often had a limited understanding of how this would affect their home equity. With each year, as interest compounds, the portion of equity retained by the borrower shrinks, directly impacting the financial value left in the home.

Depending on the age at which you take out a reverse mortgage, and whether you choose to make repayments, the outcome of a reverse mortgage and its effect on home equity may vary. Additionally, interest rate changes and property prices also have a direct impact on equity erosion. The following figure from ASIC’s 2018 review shows how an increase in variable interest rates on loans could reduce the amount of home equity that is available to existing borrowers when they reach the average retirement age of 84.

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Despite concerns about equity erosion, Australian reverse mortgages include an important safeguard: negative equity protection. This protection ensures that the borrower or their estate will never owe more than the property’s sale value, even if the loan balance exceeds it.

However, before deciding on a reverse mortgage, it’s crucial to seek independent financial advice. While negative equity protection may offer some security, the loan can still reduce the inheritance you leave behind and may limit your future financial flexibility. Understanding how your loan balance will grow and affect your estate is vital to making an informed decision that aligns with your long-term goals and those of your beneficiaries.