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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.
What is the interest rate on a reverse mortgage?
One of the most important things to consider before taking out a reverse mortgage is this: interest rates.
As we’ve mentioned, interest rates on reverse mortgages tend to be higher than standard home loans. That’s because borrowers don’t need to make repayments until the end of their loan, while standard mortgages have repayments on a monthly basis.
Wondering what is the interest rate on a reverse mortgage? Let’s run you through a range of current interest rate options from reverse mortgage lenders in Australia:
Popular reverse mortgage interest rates in Australia
Loan Name & Provider
Variable Interest Rate
Express Reverse Mortgage
ASAG Reverse Mortgage
G&C Retirees Access Home Loan
Heartland Reverse Mortgage
Household Capital Household Loan
P&N Bank Reverse Mortgage
How good are reverse mortgages?
Before you decide to apply for a reverse mortgage, it’s important to weigh up the pros and cons to make an informed decision.
Pros of reverse mortgages
- A practical way to alleviate financial stress: if you need a lump sum of cash and own your home outright, a reverse mortgage can provide access to money when you need it (especially if you’re no longer working and need to pay for large expenses like medical bills).
- Provides a lump sum of money you can use to secure an early retirement: some older Australians choose to use a reverse mortgage as a way to fund an early retirement, without having to sell their home or take out a personal loan with ongoing repayments.
- The ‘Negative Equity Protection’ released in September 2012 means you won’t end up owing the lender more than your home is worth at the end of your reverse mortgage, which gives you an added layer of protection.
Cons of reverse mortgages
There are some very significant risks with reverse mortgages that you need to consider before taking out this kind of loan. The biggest risk is that your home’s equity decreases as your debt increases.
As a loan only available to older Australians, a reverse mortgage can be a high-risk loan option that can leave you ineligible for government assistance and unable to support yourself in retirement.
Ultimately, a reverse mortgage can offer short-term benefits at the cost of long-term financial security. While it can be useful for asset rich, cash poor homeowners who need a cash boost, it should be used cautiously due to the high-interest rates and high chance of debt growth.
Before you decide to take out a reverse mortgage, make sure to chat with an experienced mortgage broker who will be able to walk you through your opinions and help you make the right move for your financial situation.
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Disclaimer: The views, information, or opinions expressed in this blog post are for general information purposes only and should not be relied upon. We have not taken into account specific situations, facts or circumstances, and no part of this blog post constitutes personal financial, legal, or tax advice to you. You should seek tax advice from your accountant, specific to your situation.