Reverse mortgages: What are they and how do they work?

Lenders often prefer to call these financial products ‘equity release’ or ‘home equity’ schemes, as that name sounds a little more appealing than calling it a mortgage product.

Generally, reverse mortgages are only available to borrowers aged 60 and over, with the money from your loan being drawn down as a lump sum, regular income stream or line of credit.

The maximum amount of equity you can withdraw with this type of loan varies between providers (currently 34–50% of the property’s value). The loan amount is calculated using your age to ensure you retain adequate equity in your property.

What are my loan options?

Most reverse mortgage lenders offer considerable flexibility in their products and how you choose to draw down on them.

You can choose to make multiple regular or irregular drawdowns, or choose to take a single lump sum.

You can use your loan for a variety of purposes or strategies, including boosting your regular retirement income, or taking a lump sum for a particular purpose (such as paying for a family wedding, holiday, home maintenance or an aged care deposit).

Some lenders also allow you to tap into the equity in your investment property or holiday home, or even refinance your existing mortgage into a reverse mortgage.

Lenders offering reverse mortgages

Currently there are only a few specialist lenders offering reverse mortgages, with none of the big banks offering these products. The main reverse mortgage lenders in the market currently are:

Important: These are not recommendations or endorsements for any of these providers

Information current as at 1 December 2020

Interest rates for these products vary from 4.95% to 5.8% (December 2020), depending on the individual lender’s product

Each lender offers a variety of products, with different strategies available depending on your requirements. The interest rate, cost, repayment requirements and loan-to-valuation ratio (LVR) vary by lender and product.

Reverse mortgages: Pros and cons

Like most financial products, there are both benefits and drawbacks with a reverse mortgage:

Pros

• Regular repayments are not required
• Repayment of the loan comes when the home is sold, or from your estate
• You benefit from any increase in the property’s value
• Interest is calculated on the outstanding loan balance and is added to the loan balance each month
• Voluntary repayments can be made at any time
• Interest rates are usually lower than personal loans or credit cards
• Interest rates are generally variable
• Avoids the need to downsize or move away from family and friends
• Some lenders allow you to borrow against a holiday home or investment property

Cons

• Interest rates generally higher than for regular mortgages
• Interest rates currently higher than the federal government’s Pension Loan Scheme (PLS)
• Compounding interest makes the loan balance increase quickly
• Additional charges can include establishment fees, monthly/annual fees, switching fees and discharge fees
• Reduces the capital available for future costs like home improvements or medical expenses
• Limits the capital available for a residential aged care deposit
• Reduces the size of your estate remaining for your family and your other beneficiaries
• Leaves less equity compared with downsizing to a smaller, cheaper home
• Some reverse mortgage lenders require you to obtain their permission before selling, leasing, vacating or renovating your property
• A non-title-holding resident may have to move out when the loan becomes repayable on your death.

Rules protecting reverse mortgage borrowers

Since September 2012, all new reverse mortgage contracts must include a protection guarantee to ensure you cannot end up owing your lender more than the value of your home when it is eventually sold.

This guarantee protects you from going into negative equity (when the value of your home is less than the outstanding balance on your loan), but it doesn’t stop the majority of the equity you have accrued in your home being eroded by the compounding interest charged on your loan.

To avoid eroding all the equity in your home, some reverse mortgage products allow you to protect a portion of your equity for your estate (usually called protected equity). If you do this, the amount you will be able to borrow will be smaller.

ASIC requires reverse mortgage lenders to provide loan applicants with a printed projection showing how their home equity will decrease over time and the impact of different interest rates on a reverse mortgage loan with a variable interest rate.

Impact of a reverse mortgage on your Age Pension

Taking out a reverse mortgage does not generally make you ineligible for the Age Pension, but you need to take care as Centrelink does impose conditions on any payments:

• Income test: Generally, the amount drawn down under a reverse mortgage is not counted as income by Centrelink. But if it is invested, it will then be deemed or counted as income. Learn more about the Age Pension income test.
• Assets test: Generally, the first $40,000 of a lump sum withdrawal from a reverse mortgage is exempt from the assets test for 90 days. If the money is not spent within the time limit, it will be counted as an asset. Different rules apply depending on whether the money is spent on assessable assets, maintenance or improvements to your home, or gifted to another person or family. Learn more about the Age Pension assets test.