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.

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