The last thing you want to think about when you retire is leaving your family home. Unfortunately this is the reality for many older people as existing income sources fail to meet their financial requirements. In recent years, financial institutions have implemented a reverse mortgage scheme which seeks to remedy this situation.
In the current economic climate, reverse mortgages seem to be growing in popularity again. It is an important time to remind potential borrowers of the benefits and risks associated with taking out such a loan.
What is a reverse mortgage?
A reverse mortgage is a loan taken out by one or more borrowers against the equity of their home. The loan is distributed either as a lump sum, regular payments or as a line of credit.
Reverse mortgages may also be referred to as 'home equity loans', 'housing equity withdrawal' or 'home equity conversion loans'.
Unlike a "forward" mortgage, a reverse mortgage does not require monthly repayments until the borrower dies, sells or vacates the home. If the borrower dies it is the responsibility of the borrower's estate to repay the loan.
In essence a reverse mortgage reduces the equity in a home whilst increasing the debt.
Why should I take out a reverse mortgage?
Reverse mortgages are usually adopted by retirees over 60 years of age. The need usually arises because the pension is not meeting a person's financial requirements or because of a sudden financial need. A reverse mortgage allows a person to use the equity in their home without having to move or make monthly repayments.
Unlike a "forward" mortgage there is no assessment of income to determine whether the borrower is capable of making monthly repayments. This means it is relatively easy to obtain a reverse mortgage if you own most or all of your home. However, it is important not to be deceived by the relative ease with which a reverse mortgage may be obtained.
What do I need to be aware of?
Borrowers need to be careful not to underestimate the financial consequences of drawing a loan against the equity of what is often their most valuable asset. Financial difficulties may arise as a result of poor research on the part of the borrower or misleading and deceptive advice given by financial institutions.
The compound interest charged on a reverse mortgage loan means that debt increases at an increasing rate. Therefore it is important for borrowers to be aware that withdrawing a lump sum loan will result in interest accruing on the value of the whole loan. It may be more appropriate to have a facility where smaller amounts are drawn down monthly so interest only accrues on these smaller outstanding amounts.
Borrowers should also be aware that the application fee and monthly fees will be included as part of the outstanding debt so will also accrue interest.
A reverse mortgage also requires careful consideration as it diminishes the estate the borrower intends to gift upon his or her death.
Lastly, a reverse mortgage may affect Government Income Support Payments. For example, it may reduce the weekly age pension allowance.
Potential borrowers may consider one of the following alternatives:
- Selling the home
Whilst this is not an option for many, potential borrowers should consider the financial position they would be in if they purchased a less-expensive home and used the difference to cater for their financial needs.
- Accessing Public Benefits
Potential borrowers should investigate whether they are entitled to any Government funded benefit schemes as this may resolve their financial need.
Reverse mortgages are often considered as a last resort (once all other assets have been used). Provided the financial need is not urgent, postponing the adoption of a reverse mortgage may be beneficial in some cases. If deferred, the borrower would be entitled to a larger loan as the home would most likely have increased in value and the borrower would be older. This would also reduce the number of years of interest accumulation.
SEQUAL (Senior Australians Equity Release Association of Lenders), which launched on 31 January 2005, is the peak industry body for the Australian Equity Release market and its mission is to ensure the professionalism of those who offer or distribute equity release products for senior Australians.
However, in the event that misleading or deceptive advice is given in relation to a reverse mortgage, complaints may be made to ASIC (Australian Securities and Investments Commission).
Whilst reverse mortgages may seem like an easy answer to financial woes, experience in Australia (UK and the US) demonstrates that they are not something to be rushed into.
Law reform in these countries has particularly emphasised the need for independent legal and financial advice when entering into a reverse mortgage. Reverse mortgage loans now offered in Australia require a borrower to provide verification that independent legal and financial advice has been obtained.
Despite this, when investigated properly, reverse mortgages are an innovative way in which older people may solve their financial difficulties without losing undoubtedly one of their most treasured assets – the family home.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.