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With the cost of residential property at all-time highs, it can be tempting for asset-rich and cash-poor retirees to look at ways of unlocking some of the money they have tied up in their home to help pay for their retirement expenses, particularly if their super account is small.
One solution to this dilemma can be to take out a reverse mortgage, which works a little like a home loan in reverse. These loan products can provide either, a lump sum for a major expense like necessary home renovations, or an income stream to top up your regular income.
While they sound like an easy solution, reverse mortgages also have a down side. The reverse mortgage debt can quickly snowball, leaving you with less equity in your home for longer-term expenses such as moving into a retirement village or aged care, so careful thought is needed before signing up.
What are reverse mortgages?
A reverse mortgage is a different form of home loan than those used to buy a residential property. A reverse mortgage allows you to borrow money against the equity (value of your home less any mortgage debt) you have built up in your home as you repaid your mortgage.
Generally, reverse mortgages are only available to borrowers aged 60 and over and loan drawdowns are paid as a lump sum, income stream or line of credit.
The maximum amount of equity you can withdraw with this type of loan varies between providers (usually 15%-45%) and the maximum drawdown is normally based on your age, to ensure you retain adequate capital in your property.
With a reverse mortgage, interest is charged just like a normal home loan, but repayments are not required. Instead, the interest compounds over the years and is added to the initial loan amount.
You retain ownership of your home and you can remain there for as long as you wish, or until your estate is wound up, at which point the loan is repaid.
Most lenders offer considerable flexibility in their reverse mortgage loan products. Borrowers can usually make multiple drawdowns and repay their loan in full, or part, at any time without penalty.
Lenders offering reverse mortgages
Currently the main lenders offering reverse mortgages are BankSA, Bankwest, Commonwealth Bank, Heartland Seniors Finance and P&N Bank.
The federal government also offers a form of reverse mortgage – the Pension Loans Scheme (PLS). Although the PLS is currently not available to FULL Age Pensioners, from 1 July 2019 those eligible to qualify for a loan under the scheme will be expanded. For more information about the PLS, see SuperGuide article What is the Pension Loans Scheme, and how does it work?.
Reverse mortgages: Pros and cons
Like most financial products, there are benefits and drawbacks with reverse mortgages and if you are thinking about taking out this type of loan, make sure you consider the loan carefully and seek professional advice before signing up. Set out below are some of the key advantages (pros) and disadvantages (cons) with reverse mortgages.
- No regular repayments required
- Repayment is made 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 to reduce the loan balance and interest charges
- Useful for funding immediate expenses, with repayment made in future years
- Usually cheaper interest rates than unsecured credit such personal loans or credit cards
- Interest rates are generally variable, with some fixed-rate loans available
- Older borrowers can take out larger reverse mortgage loans
- Allows you to stay close to friends and family rather than downsizing into a cheaper property in a new area
- Interest rates generally higher than for regular mortgages
- Compounding interest makes the amount owed balloon quickly
- Any fees and charges may also accrue interest
- Fees can include upfront establishment fees, monthly/annual fees and discharge fees
- Reduces the money available for a loan or sale from your property in the future, for costs like home improvements or medical expenses
- Limits the amount available for aged care (refundable accommodation deposit)
- Reduces the money left in your estate for your beneficiaries
- Leaves less equity compared with downsizing to a smaller, cheaper home
- Income is counted under the income test for the Age Pension, while lump sum amounts not immediately spent can be considered under the assets test
- Anyone residing in the property may have to leave when you die, and the loan becomes repayable
Rules protecting reverse mortgage borrowers
After some poor borrower experiences with early reverse mortgage products, since September 2012 all new reverse mortgage contracts include a ‘negative equity protection’ guarantee. This protection is to ensure reverse mortgage borrowers cannot end up owing the lender more than the value of their home when it is eventually sold.
Although this guarantee protects you from going into negative equity, it does not stop the majority of the equity you have accrued in your home from being eroded by the compounding interest charged on the loan. Reverse mortgage borrowers can still end up with very little left after they terminate their loan.
Note: 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). Although these options ensure you will always own a specific portion of your home, the amount you will be able to borrow against your home will be smaller.
Everyone applying for a reverse mortgage is required to get independent legal and financial advice before a lender will provide loan financing.
Since 1 March 2013, ASIC also requires lenders to provide loan applicants with a printed reverse mortgage projection showing how their home equity will decrease over time and the impact of changing interest rates on variable loans.
You can check out ASIC’s Money Smart Reverse Mortgage Calculator here (you leave the SuperGuide website when you click on this link).
Impact of a reverse mortgage on Age Pension eligibility
Generally, taking out a reverse mortgage does not make you ineligible for the Aged Pension, but Centrelink does impose several conditions on such payments, so you need to take care.
Under the Centrelink rules, both FULL and PART Age Pensioners can draw a lump sum from a reverse mortgage, but only $40,000 of the total amount drawn down is exempt from the asset test. The $40,000 only remains exempt for 90 days, however, so the money needs to be spent within this time limit to avoid running foul of the means-testing rules.
Important note: Centrelink will deem under the income test, any lump sum withdrawn using a reverse mortgage, from the day it is drawn down from the lender.
If you draw an income stream from a reverse mortgage it is generally not counted as income by the Age Pension income test and, if spent immediately, it will not affect your Age Pension. If you leave the money accumulating in your bank account, however, it will become subject to Age Pension means testing.
For more information…
For more information about how much is enough for retirement, and how to secure that income in retirement, see the following SuperGuide articles:
- How to plan for your retirement
- How much super do I need to retire?
- How much super do I need to retire on $60,000 a year?
- Understanding your life expectancy
- Income from super Reckoner
- Super to income Reckoner
- What is the retirement age in Australia?
- When should I retire?
- Retirement age calculator: When can you access your super or the Age Pension?
- What age can I access my super (Preservation Age)?
- What is the current Age Pension age?
- Downsizer contributions: How do they work and what are the current rules?
- What is the Pension Loans Scheme, and how does it work?
- How to find low cost (or free) financial advice