How Do Reverse Mortgages Work?

If you’re age 60 or over, you’re probably thinking of ways to make your retirement more comfortable. After all, retirement years are supposed to be a time of relaxation, not financial stress.

Whether it’s for your medical expenses, home renovation, or just having a little extra cash on hand each month, financial flexibility can make a difference.

Reverse Mortgages are a popular choice for Aussies looking to top up their retirement income. But how do they work? Let’s take a look.

What is a Reverse Mortgage?

In simple words, a reverse mortgage loan is essentially an equity-release product. It lets you borrow money while using your equity in your home as security.

So, if you’re an Australian homeowner age 60 and over, releasing your home’s equity may be a suitable way to supplement your retirement income without needing to sell your home.

While you’ll have to pay interest like with any other loan, you (the borrower) are not required to repay the loan. In most cases, you can make voluntary repayments if you wish. However, once you or your estate sells your property, your reverse mortgage loan must be repaid to your lender in full.

“You could say reverse mortgage products are designed for ‘asset-rich, income-poor’ pensioners and retirees looking for more liquidity. It’s another reason reverse mortgages are one of Australia’s preferred forms of home equity release,” states Graeme John, Head of Growth at Joust.

As per industry reports, the market size in 2022 of the Reverse Mortgage Lenders industry stands at a significant $271.0m when measured by revenue. Furthermore, it is expected to rise by 4.7% in the same period, given the rising population is aged 70 and older. Also, the number of reverse mortgage borrowers is predicted to increase over the next five years.

Why Should I Care About Reverse Mortgages?

Depending on your personal circumstances, you may want to support your long-term retirement funding with a regular income stream.

With reverse mortgage contracts, you can access the equity in your home without selling it. So, your home doubles up as the best place to live and a great source of retirement income.

Whether it’s for creating a regular monthly income source, undertaking renovations to make your home retirement-friendly, healthcare expenses, travel plans, buying a new car or funding your move to aged care, you can make the most of your home equity to support your retirement.

Who Can Get a Reverse Mortgage?

You can get a reverse mortgage if you’re an Australian aged 60 or over and own your home. It will help you supplement your retirement income by releasing equity from your home.

How Do Reverse Mortgages Work?

To begin with, you will have to take a loan either as a lump sum payment, line of credit or an income stream.

You can continue living in your primary residence as long as you want, enjoying full ownership. In addition, you don’t have to make any repayments while living there.

The interest gets capitalised, which adds to the loan balance. The compounding interest, over time, gets more significant as it adds to the amount you borrow. Notably, being a non-conventional loan, the interest rate on reverse mortgage loans is often higher than on a standard home loan.

Your loan balance continues to increase unless you choose to make voluntary payments. Doing so allows you to retain some home equity instead of being polished off by the loan. Some homeowners make voluntary payments to ensure they have enough money to pay for aged care.

You repay the loan, including all the interest and fees, in full when:

• You sell the property on your wish.
• You move into aged care (for some lenders).
• If you’re a couple, the last surviving borrower passes away.

Depending on lending criteria, the fees will vary. Nonetheless, establishment fees, ongoing fees and valuation fees are common.

As with all major financial decisions, you speak to a financial advisor or have your lender or broker explain the reverse mortgage projections. This will help you know the impact on your home equity and financial situation over time and facilitate informed decisions.

Negative equity protection

An essential feature of reverse mortgages is negative equity protection.

Reverse mortgage borrowers now have negative equity protection for reverse mortgages taken out from 18 September 2012. With all the new reverse mortgage contracts, you can’t end up owing your lender more than the value of your home (market value or equity).

So whenever you go in for a reverse mortgage, check your contract and see that it includes negative equity protection. If not, be sure to speak to your lender or get independent advice on your next step.

Reverse Mortgage with an Existing Mortgage

Most reverse mortgage providers state that your existing property should be mortgage-free, i.e. you should own 100% equity in your property.

If you don’t have full ownership of your home, you must pay off your outstanding balance on the mortgage with the reverse mortgage.

How Much Can I Borrow?

You can at most borrow around 15–20% of your property value. For your reference, you may add 1% per year over 60. This way, at 65, the maximum amount you can borrow will be around 20–25%.

While lending criteria vary, the minimum borrowing amount typically is about $10,000.

What is the Interest Rate on a Reverse Mortgage?

According to data published on ASIC, reverse mortgages are a more expensive form of credit than the standard variable interest rate for owner-occupier home loans.

To be precise, the interest rates are usually around 2% higher. This is mainly because no monthly loan repayments are required, and the interest compounds faster than your typical loan - especially where borrowers have opted for lump sum payments. 

Pros and Cons of Reverse Mortgages

While deciding whether or not to take out a reverse mortgage, it’s essential to be aware of all the potential risks and rewards. Here are some factors to weigh up against your personal objectives before making your decision.

Pros of Reverse Mortgages

1. Live in your own home: Some pensioners and retired homeowners may have to sell out, downsize or relocate to manage their retirement living costs. On the other hand, with access to sufficient cash flow, you can live at your home for as long as you want. Moreover, if you have an existing loan balance, it will be paid off through the reverse mortgage payout. This way, you get full ownership of your home and are free from multiple debts on your same property.

2. Increase your retirement income: Where you could be facing cashflow problems post-retirement, a reverse mortgage is a suitable strategy to minimise financial stress, supplement your retirement income and cover your living expenses. Most lenders will offer you the choice of borrowing a lump sum, opting for regular instalments or a line of credit.

3. Have a comfortable lifestyle even in retirement: Since you have access to extra cash flow with a reverse mortgage loan, you can enjoy your retirement even better. You can take more vacations and pay for your healthcare and other living expenses without much financial stress.

4. Negative equity guarantee: Now that reverse mortgages from September 2012 have ‘negative equity protection,’ you can rest assured that neither you nor your dependents will owe your lender more than the value of your home when the reverse mortgage period is completed.

Cons of Reverse Mortgages

1. High-interest rates: High interest rates may affect your retirement income as reverse mortgage rates, and fees are typically more than standard home loans. Furthermore, your debt may rise quickly due to interest compounding over the loan term. That said, if you look to fix your interest rate, it can work costlier to break the agreement.

2. Reduces your equity: Over time your equity in your home diminishes as your debt builds up. The interest on your reverse mortgage increases over time as it’s compounded, thereby increasing the home loan amount. This reduces your equity at the time of selling your property.

3. Impact on age pension: Your reverse mortgage may affect your pension or how much you receive in other government benefits. You should therefore seek personal financial advice to know how your reverse mortgage works regarding your pension.

4. Age limit: To qualify for a reverse mortgage, you must have complete ownership. Depending on the lender, some require you to be over the age of 65.

5. Others: A reverse mortgage may leave you or your beneficiaries with lesser wealth from the sale proceeds than had you not opted for it. This is because the reverse mortgage with the substantial compound interest has to be paid back, especially if you received a lump sum payout. Finally, you may not have adequate money for your aged care or other future needs once the reverse mortgage has been repaid.

Is a Reverse Mortgage a Good Idea?

The answer to this question depends on your personal circumstances. Your home is one of your most significant assets and can be a security source in retirement. So, it’s understandable that you might be unsure whether to enter into a reverse mortgage.

However, here are some things to consider that might help you make a decision:

1. Interest and Fees: The interest rates and fees for reverse mortgages are typically higher than regular mortgages. In short, you or your estate could potentially be left with very little equity in your home, i.e., not much money once your home is sold and your reverse paid back.
2. Your pension. Assess the impact of a reverse mortgage on your pension and other government entitlements, taking professional advice if needed. Like any loan, a reverse mortgage entails a financial obligation you should be ready to meet.
3. Loan payments. If you need this loan, consider which option would suit your needs the most.
4. Lump Sum Payment: This option is feasible if you want immediate funds for consolidating debt, renovating your home, or even a long-cherished travel plan.
5. Regular Income: By setting the amount you want to receive to manage your monthly expenses, you can get a regular drawdown payment for up to 10 years.
6. Cash Reserve: This option is ideal if you want to set up a cash reserve that you can access whenever you need it. The advantage here is that you’ll have to pay interest only on the amount drawn. In fact, your lender may not set a minimum drawdown amount. Some may even let you access the funds directly via a debit card at ATMs.‍
7. Potential expenses: You could compile your income and expenses to estimate future needs and how you would afford them. Keep in mind your advancing age, health and living requirements in the coming years. Allocate budgets toward healthcare expenses and aged care while assessing how a reverse mortgage can help you save money to cover them.‍
8. Life changes: Understand the implications in case you want to sell, vacate, rent or renovate your house at some point in the future or if you or your partner dies. Get complete clarity from your lender on how these events will affect your mortgage. Also, discuss the possibilities if someone moves in to live or if you want to transfer your loan to another house if you relocate.

Once you have assessed the pros and cons and explored the different scenarios, you can decide if a reverse mortgage is the right choice for you.

What Are The Alternate Options To Reverse Mortgages?

If a reverse mortgage is not the right solution, other options exist to help you access a home loan on your retirement income. These include:

1. Line of Credit: You can borrow funds using the equity in your home and draw down and repay your loan as you choose.
2. Variable and Fixed-Rate Pensioner Home Loans: These loans are similar to those offered to home buyers in general.
3. Bridging Loan: This loan helps you bridge the gap between when you buy a new home and sell your existing home.
4. Investment Home Loan: If you’re a retiree, you may still qualify for a loan to purchase an investment property. 
5. Home Equity Access Scheme (Earlier the Pension Loans Scheme): A home loan that enables eligible Australians to get a voluntary, non-taxable fortnightly loan from the Federal Government.
6. Disability Support Pension: If you’re receiving a disability pension, some lenders will treat your income as genuine income and assess your application like regular applicants.
7. Veterans’ Pension: Since it’s considered a guaranteed regular income, you may be able to access various home loan options offered to standard borrowers.

Which Banks Offer Reverse Mortgages in Australia?

G&C Mutual Bank, Heritage Bank, IMB Bank, P&N Bank, Heartland Reverse Mortgages, and Household Capital offer reverse mortgage loans in Australia.

However, ANZ, Commonwealth Bank, Bankwest and St. George do not currently offer reverse mortgages. Moreover, Westpac does not offer reverse mortgages. Instead, it provides loan increases to enable you to access the equity in your home.

Why Should You Consider Joust?

Instead of crawling through the market manually for competitive home loan rates, Joust can provide you with all the information you need at the click of a button. 

No matter what type of loan you need, Joust Live Auction provides competitive home loan rates matched to your financial situation. The best part is that the platform is completely free!

Frequently Asked Questions (FAQs)

Who Owns the House in a Reverse Mortgage?

With a reverse mortgage, you’ll continue to be the full legal owner of your property. You can stay in it for as long as you desire. Your lender will only take the mortgage.

As long as you do not ‘default’ under the agreement by breaching key obligations, your lender cannot force you to sell your home.

What If I Want to Sell My Property?

When you decide to sell your house, move into an aged care home, or pass away, your reverse mortgage loan will need to be repaid in full, including interest and fees.

Will a Reverse Mortgage Affect my Pension?

A reverse mortgage may affect your pension or other Government benefits that you can access. For this purpose, it’s recommended that you seek proper financial advice from Centrelink or speak to a financial expert on how your pension may be affected.

Are there Costs for Repaying the Loan Early?

You can repay your reverse mortgage loan early if you desire. No extra costs are levied if you partially or entirely repay your reverse mortgage loan.

Are Reverse Mortgages Regulated?

With the passing of the National Consumer Credit Protection Act (2012), reverse mortgages have become one of Australia’s most highly regulated credit products. As a result, explicit protective measures have been implemented for consumers at the start and end of the loan process.