What Is A Reverse Mortgage?
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Loading... - Isabella Martel
- 25 May 2022
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Typically, securing a home loan means saving up a deposit, borrowing money from a lender and committing to monthly loan repayments. But with a reverse mortgage, homeowners are able to tap into the value of their existing home and receive a lump sum payment or line of credit.
This unique type of home loan is available to older Australians over the age of 60 and is used to convert a home’s equity into cash.
But before you consider a reverse mortgage, it’s important to understand how a reverse mortgage works, the interest rates you’ll be charged with and whether the risks will outweigh the rewards for you.
What is a reverse mortgage?
A reverse mortgage is a type of home loan available to older Australians. It allows these homeowners to access the equity tied up in their property in exchange for cash to put towards home renovations, medical expenses, living costs or anything in between.
As an equity release product, a reverse mortgage is designed for homeowners that are “asset rich” (a.k.a. they own their home outright) but “cash poor”. That’s why it’s often used by homeowners who are navigating financial stress but don’t want to sell their home or face immediate loan repayments.
To be eligible for a reverse mortgage, homeowners must be over the age of 60 and own property without a mortgage. The amount you can borrow depends on the value of your home as well as your age (but usually ranges between 15-20% of your property’s value).
How does a reverse mortgage work in Australia?
In a nutshell, a reverse mortgage allows you to access the equity of your property in cash.
Generally, a 60-year-old homeowner will be able to borrow 15-20% of their property’s value (with this number increasing 1% per year). That means by age 65, you’d likely be able to borrow 20-25% of your property’s value.
Here’s how a reverse mortgage works in Australia: this type of loan allows you to remain in your home without needing to make repayments while you live there.
Over time, interest is charged on your loan amount and compounds - this means your total loan amount grows. Plus, your interest rate is typically higher than a standard loan (but more on this in a minute).
When you decide to sell your home, this loan is payable in full (including all the interest and fees that have been added to the loan, too).
What are the costs of a reverse mortgage?
Just like any other type of home loan in real estate, a reverse mortgage comes with a few upfront costs, including:
· Establishment fees: anywhere from $500 to $900 or more
· Loan discharge fees: anywhere from $300 to 400
· Application to increase the credit limit: anywhere from $395 to $950 or more,
However, the biggest cost to consider when it comes to a reverse mortgage is the interest that compounds over the life of your loan. Essentially, as time goes on the interest charged on your loan increases, meaning your total debt grows
Let’s walk you through what this means in dollar terms, based on a reverse mortgage of $50,000:
· After 1 year, you’ll have accrued $4,420 in interest = total loan amount of $54,420
· After 2 years, you’ll have accrued $9,230 in interest = total loan amount of $59,230
· After 10 years, you’ll have accrued $66,632 in interest = total loan amount of $116,632
To work out how much a reverse mortgage might cost you, check out Money Smart’s reverse mortgage calculator.
What are the risks of a reverse mortgage?
A reverse mortgage does come with a few extra considerations, especially when it comes to compound interest.
Here are a few of the key risks to keep in mind before applying for a reverse mortgage:
· Your debt can rise quickly: if you choose to keep your reverse mortgage for a long time, your debt will continue to grow as both your initial loan amount, fees and interest payments will increase over time.
· Your interest rate is usually higher: one of the biggest risks of a reverse mortgage is the higher-than-average interest rates (usually 4-6%), compared with standard loan rates (usually around 2-3%).
· You can impact your long-term financial future: as your debt can rise rapidly, a reverse mortgage can chip away at your wealth and make it difficult to live a comfortable lifestyle once you sell your home and repay the loan.
· You may affect your eligibility for the age pension: plus, having a reverse mortgage can prevent you from being eligible for the age pension. That’s because the upfront lump sum payment you receive from your loan can count towards the asset and income tests used to calculate eligibility.
