Reverse mortgages and their limitations
What is a reverse mortgage?
A reverse mortgage allows seniors and retirees to use the equity in their home to take out a loan which is then paid back, with interest, when the homeowner sells, downsizes or dies. Interest rates however tend to be high and that interest compounds from day one, which increases the loan amount if there are no regular repayments.
How does a reverse mortgage work?
Many Australian seniors own their home outright after many years of paying off their mortgage. This valuable asset is not included in the pension assets test, however without any other significant income, it can make seniors asset rich but cash poor. This low cash flow sees some seniors use the equity in their homes to secure a loan through a reverse mortgage.
How do you pay back a reverse mortgage?
Unlike a standard home loan, the reverse mortgage is paid off when the home is eventually sold. What’s more, the interest owed compounds, which means that without regular repayments, any outstanding interest owing is added to the total amount of the loan.
For example, in just seven years, a $100,000 reverse mortgage at 6% per annum and no repayments can become a debt of $150,000, and takes just 12 years to double.
So not only do you own less of your home, with the lender now owning a proportion of it, you have less control over your single most valuable asset.
Are there better alternatives?
If your super is running low and you’re retired, talk to your fund about how your super and the age pension could work together. You can receive up to $4,500 income from your super, tax free, each year without it reducing your age pension – even if you’re on the full pension rate.
And if money does become tight, you may also be able to apply for a low-interest pensioner loan (PLS) from the government against the equity in your home. The PLS is at a rate that’s generally more affordable than personal loans or reverse mortgages.
Before making a decision on reverse mortgages, personal loans or pension loans you should inform yourself of the pros and cons and seek independent financial advice.