Reverse Mortgages work in an opposite manner to the traditional home loans – hence the name ‘reverse mortgages’. With a traditional home loan you borrow money to buy a house and make regular payments to repay your loan and in the process you build up equity in your home. With a reverse mortgage, you borrow money against the equity of your home. The lenders will either pay you a lumpsum or will make regular payments. Some lenders even have the option of ‘line of credit’. You don’t have to make regular repayments to clear the loan. The interest and the fees are added on every month to the loan balance. The total money you owe keeps increasing and at the end of the loan term your house is sold and the proceeds are used to clear your loan.

Reverse Mortgages can be a boon for a lot of asset rich, cash strapped retirees.

To qualify for a reverse mortgage you need to be between 60 and 65 years of age. You need to fully own your home. You can’t take a reverse mortgage if you are still paying the original mortgage on your home. Usually the lenders will lend you anywhere between 15 and 60% of the value of your home. The older you are the more you can borrow. On the surface, though reverse mortgages seem like a good option, a lot of caution and thinking needs to be exercised before opting for a reverse mortgage.

In January 2005 a non profit association called ‘Senior Australians Equity Release Association of Lenders (SEQUAL)’ was formed. This body along with Australian Securities and Investment Commission act as a regulatory body for the lenders who offer reverse mortgages. You should always only deal with a lender who is approved by SEQUAL.

Here are a few facts and observations about reverse mortgages:

• The interest rate charged is usually higher than that of a traditional home loan.
• Since the interest and fees are added on to the principal every month, the new loan balance is your original balance plus the new interest and fees. Now you are seeing the negative side of compounding effect. Interest is charged on interest…So very soon your loan balance balloons up. At an interest rate of 8% your loan balance can double in less than 10 years.
• These loans can affect your centrelink payments. You need to check with an accountant and centrelink before signing up.
• If your home is jointly owned by you and your partner and one of you dies then the lender cant evict the other one..So thats good news. But the problem comes when the property is just in one name and if that person dies then the lender can evict the other person from the property.
• Only go with a lender that offers ‘No Negative Equity Guarantee‘. This means the total amount of money you owe will never exceed the sale value of the house. So in the end after the sale of your house you will not owe the lender any additional money. Please be aware that this guarantee usually comes with a condition that the house should be of certain standard at the time of the sale. Read the fine print and make sure that there are no improper clauses attached with this guarantee.
• It usually is not possible to determine in advance how much money you might get after the sale of the house. If you are planning to move to an aged care facility then be aware that the money you get from the sale (after paying the lender) might sometimes not be enough to cover your expenses. So if this home is your only asset please be cautious before taking this kind of mortgage as at the end of it all you might not be left with anything.
• If you take a reverse mortgage with a fixed term then be aware that you might have to sell and repay the loan in your lifetime.
• Try to keep your borrowing to minimum.
• I am probably stating the obvious here – opting for this loan will reduce the inheritance your kids can get.
• Make sure you read the fine print thoroughly…Seek necessary advice and get all the information, conditions, clauses and terms in writing.

Reverse mortgage can be a good product if understood and used properly. Don’t just borrow because you have the option. Reverse mortgages should be you last option because whatever said and done you are paying interest on interest and accumulating a huge loan balance.

Have you had any experience with these loans? What are your thoughts about these loans?

Topics: Retirement | 2 Comments »

2 Responses to “How Do Reverse Mortgages Work?”

1. ILLIYA Says:
   August 22nd, 2008 at 2:23 pm

   Hi,
   The article is very interesting,
   What happens when someone borrows around 60% of the value of the property and the value of the property depreciates, say the housing market plunges by 45% and banks are forced to raise the interest rates?

   Will the bank be the looser? I doubt?

2. Sandy Naidu Says:
   August 22nd, 2008 at 8:06 pm

   Good question Illiya. Here is my understanding:

   Banks can raise interest rates irrespective of rising or falling property prices. It is up to them. Especially if the reverse mortgage has a ‘no negative equity guarantee’, they probably do raise rates – to protect themselves.

Comments

Name (required)

Mail (will not be published) (required)

Website

Notify me of followup comments via e-mail

« Australians Are World’s Worst Savers….Oh No !!! | Home | Give Your Mindset A Shaking…. »