Borrowing against your home
A reverse mortgage can help older Australians unlock the wealth in their homes after retirement. However, there can be long-term financial risks.
What is a reverse mortgage?
A reverse mortgage is a type of loan that allows you to borrow money using the equity in your home as security. The loan can be taken as a lump sum, a regular income stream, a line of credit or a combination of these options.
Interest is charged like any other loan, except you don’t have to make repayments while you live in your home – the interest compounds over time and is added to your loan balance. You remain the owner of your house and can stay in it for as long as you want.
You must repay the loan in full (including interest and fees) when you sell or move out of your home or, in most cases, if you move into aged care, or die.
While no income is required to qualify, credit providers are required by law to lend you money responsibly, so not everyone will be able to obtain this type of loan.
The risks of a reverse mortgage
An ASIC review of reverse mortgage lending in Australia found that borrowers can struggle to recognise the long-term risks of their loan.
By taking out a reverse mortgage, you could face financial difficulty later in life, because:
- interest rates and ongoing fees are generally higher than the average home loan
- your debt will increase as interest rates rise on your loan
- the effect of compound interest means your debt can increase quickly as the interest compounds over the term of the loan
- if the value of your home does not rise, or it falls in value, you will have less money for your future needs, like aged care or medical treatment
- the loan may affect your pension eligibility
- if you have a fixed interest rate loan then the costs to break your agreement can be very high.
Also keep in mind that if you are the sole owner of the property and someone lives with you, that person may not be able to stay when you move out or die (in some circumstances).
How much can you borrow with a reverse mortgage?
The older you are, the more you can borrow. Different lenders may have different policies about how much they will let you borrow.
As a general guide, if you are 60, the maximum amount you can borrow is likely to be 15-20% of the value of your home. You can usually add 1% for each year older than 60. That means if you are 70, the maximum amount you could borrow would be about 25-30%.
The minimum amount you can borrow may depend on the provider; it could be as low as $10,000. Keep in mind that if you borrow the maximum amount now, you may not have access to any more money later.
How much will a reverse mortgage cost?
The cost of the loan depends on the interest rate and fees. The main issue is that as the interest compounds, the debt will grow rapidly.
Figure 1 shows how compound interest could make a debt grow by almost $158,000 in interest, if the interest rate rises by 2%.
Figure 1: Effect of compound interest on a reverse mortgage loan
Assumptions: $118,627 loan at age 65, no regular withdrawals. Interest rates increase from 6.3% to 8.3%, calculated and charged monthly. House valued at $632,598.
Questions to ask the reverse mortgage provider
Before you sign on the dotted line, check the following.
Reverse mortgage information statement
Do you understand how a reverse mortgage works? Your credit provider or credit assistance provider (such as a broker) must give you a ‘reverse mortgage information statement’.
The information statement includes:
- details about how a reverse mortgage works
- how costs are calculated
- what to consider before taking out a reverse mortgage
- useful contacts for more information.
Reverse mortgage projections
What is the long-term impact of a reverse mortgage? Before you sign up, your credit provider or credit assistance provider must go through reverse mortgage calculations with you, using MoneySmart’s reverse mortgage calculator.
These projections will:
- illustrate the effect a reverse mortgage may have on the equity in your home over time
- show the impact of interest rates and house price movements.
You must receive a copy of these projections to take away with you (e.g. a printed copy, or by email). Make sure you understand how the projections work and how changes in interest rates and house prices could change how much equity you hold in your home. Be aware that the projections are only an estimate and not a guarantee of how much equity you will have if you take out the loan.
If there’s anything you’re not sure about, ask the loan provider to explain it to you. Or come and see our friendly accountants for further information and advise.
By: Rachel Cooper