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If your super account is not as big as you want when you retire, one solution could be to look to your home as a way to generate some extra money – and that doesn’t mean becoming an AirBnB host.
One way to unlocking some of the money you have tied up in your home to pay your retirement expenses is to take out a reverse mortgage. These loans work a little like a home loan in reverse and can provide you with either a lump sum or an income stream.
While reverse mortgages can be a useful solution for cash-poor retirees, they have their downsides, so retirees need to understand how they work and consider their potential impact when it comes to longer-term expenses like aged care.
Need to know
Reverse mortgages are complex financial products, so always seek independent legal and financial advice on the impact of this type of loan 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 is normally based on your age to ensure you retain adequate equity in your property.
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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.
Angela is aged 65 and lives with her husband Tom (aged 68) in their home (currently valued at $850,000) in an inner Melbourne suburb. They live close to family and friends, so are reluctant to downsize.
Although their super balance covers most of their retirement expenses, they would like to boost their monthly income by taking out a reverse mortgage.
Angela and Tom estimate their home will increase in value 3% annually and decide they would like to receive regular monthly payments of $1,000 over the next 15 years. (The interest rate charged by their reverse mortgage lender is 7% per year, with a $1,000 establishment fee and no ongoing fees.)
In 15 years, Angela and Tom’s home is expected to be valued at $1,324,272 and the loan amount owing will be $319,811. This will leave them owning 76% of their home’s equity ($1,004,461).
If the interest rate on their loan rises 2%, they will owe $382,244 to their lender and own only 71% of their home’s equity ($942,028).
Lenders offering reverse mortgages
Currently there are only a few lenders offering reverse mortgages, with none of the big banks offering these products. The main reverse mortgage lenders are Heartland Seniors Finance, P&N Bank, IMB Bank and G&C Mutual Bank.
The federal government also offers a form of reverse mortgage – the Pension Loans Scheme (PLS). For more information, see SuperGuide What is the Pension Loans Scheme, and how does it work?.
Reverse mortgages: Pros and cons
Like most financial products, there are both benefits and drawbacks with a reverse mortgage:
- 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 for personal loans or credit cards
- Interest rates are generally variable, with some fixed-rate loans available
- Avoids the need to downsize or move away from family and friends
- Interest rates generally higher than for regular mortgages
- Compounding interest makes the loan balance increase quickly
- Additional charges can include establishment fees, monthly/annual 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 beneficiaries
- Leaves less equity compared with downsizing to a smaller, cheaper home
Rules protecting reverse mortgage borrowers
Since September 2012, all new reverse mortgage contracts include a ‘negative equity protection’ guarantee to ensure 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 being eroded by the compounding interest charged on the loan.
Need to know
If you hold a reverse mortgage over a long time period, you can end up with very little equity in your home left when you terminate your loan.
This may cause problems if you or your partner need a significant lump sum for an expense like a refundable accommodation deposit (RAD) for residential aged care.
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.
Since 1 March 2013, 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 changing interest rates on a variable interest rate loan.
Impact of a reverse mortgage on your Age Pension
Taking out a reverse mortgage does not generally make you ineligible for the Aged Pension, but you need to take care because 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.
- 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.
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