What is a Reverse Mortgage?

Posted on 05 SEP

We read the following article online and thought it might be of interest to our readers. The Australian Securities and Investment Commission (ASIC) are reviewing reverse mortgages:

 What is a Reverse Mortgage?

Essentially, it is a loan that allows you to borrow money against your home by using the equity built up in your home as the security. This type of loan can be taken as a lump sum, a regular income stream, a line of credit, or a combination of these.

With this type of loan, although there aren’t repayments while you live in your home, there is interest charged like any other loan. The interest will compound over time and be added onto your loan balance.

These types of mortgages are usually taken out by retirees to complement their lifestyles and provide an additional income stream during retirement years.

However, there are many long-term financial risks when taking out these loans.

As these loans are mainly taken out by retirees, the loan must be repaid in full (including interest and fees) when you move into aged care, move out, or pass away. Until this time, you are able to stay and live in your own home, all the while accumulating interest and reducing the value of your estate.

Risks

The current ASIC review of reverse mortgage lending in Australia found that borrowers typically do not recognise or understand the long-term risk of taking out this type of loan.

There are large risks when taking out a reverse mortgage, the main risk being severe financial distress later in life.

Some of the risks associated with these loans:

• The payments may impact your pension eligibility.
• The banks will offer higher interest rates and charge higher ongoing fees than the average home loan.
• As you are aging in life, your debt will increase as interest rises on your loan.
• Debts will increase quickly as the interest compounds over time.
• The value of your home is not guaranteed to always rise, and if the value of your home falls, you may have less money than expected for future medical treatment or aged care.
• Maybe high break costs involved.
• In some circumstances, if you have someone living with you, not on the mortgage, such as children, family or friends, that person may not be able to stay if you move out, or pass away as the bank will need to recoup their loan.

We strongly advise that if you are considering taking out a reverse mortgage you seek independent financial and legal advice as well as speak to your family as there may be other ways to obtain funds in your retirement years.