29 May 2005

Q & A – Reverse Mortgages Explained

My parents are retired and receiving the pension. They have lived in the same house for 37 years and as you can imagine the value has increased considerably. Like a lot of people in their age bracket they are asset rich, but cash poor. They do not want to sell to access some of this case, but they can see no other option. I’ve heard in the press about reverse mortgages. How do these work?

Many Australians are finding that while their superannuation, savings or pension allow them to meet their immediate needs, they do not allow them to continue with the lifestyle they enjoyed when they were employed or, more importantly, they cannot fund emergencies.

The irony is that most people who fall into this category own a home worth many hundreds of thousands of dollars. Borrowing is easy, but they do not have the income to support the repayments.

A reverse mortgage is a relatively new mortgage product allowing people like your parents the opportunity to convert some of the equity in their home into cash. It is called a reverse mortgage because it works in the opposite way to a traditional home loan which decreases over the term of the loan. Retirees can borrow money to live on without having to make repayments until they sell, move into a retirement village/nursing home or pass away. Each year the fees and interest they would normally pay are added to the loan, thus increasing the amount owing over the term.

Your parents could be able to borrow between 10% and 40% of the property value and up to a maximum of $1,000,000 (most less than $250,000) depending upon the lender. Reverse mortgage interest is higher than on standard loans and the interest is capitalized and compounded. In other words, you are paying interest on interest.

Interest repayments can be reduced if the reverse mortgage allows them to draw down amounts as needed rather than taking a lump sum upfront. There are several options available depending on your parents’ needs.

While a reverse mortgage is one solution available to your parents, it may not be for everyone. If the property is owned by only one spouse, and they pass away or move into care, the loan will have to be repaid. This could mean that the spouse, who is not an owner, may have to move out of the property, putting stress on that person.

As the debt grows through compounding interest and fees (at 7.5% interest the loan amount could double within 10 years), it may mean your parents do not have enough money left if they choose to move into a retirement village. Also, any borrowings made against the home may reduce your inheritance. This impact could be reduced if their home increases in value. A reverse mortgage may also impact on their Centrelink payments, so it is important for them to speak to family and Centrelink prior to the loan being arranged.

Fortunately, most lenders now require that reverse loan borrowers obtain third party advice as a condition of lending. So, before your parents go to sign up for a reverse mortgage, make sure that they get both independent legal and financial advice. This will help uncover exactly how the loan could affect them and their heirs in the long term.

The best place to start is by contacting me so I can answer your questions in more detail regarding your parents’ situation. I look forward to helping in this regard.

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