SALLY ELFORD / IKON IMAGES / GETTY IMAGES
The great Australian dream of owning your own home has often led to people putting every spare cent into the mortgage. This is leading to many people retiring asset-rich but cash-poor. They own their own home but are struggling to live day-to-day as they have little or no income-producing assets to provide them with the cash to do so. This is especially true of retirees whose working life predated the superannuation guarantee or who only took part in it for a short time.
So while spending their working lives paying off their home to secure their future, many people are finding that future is not providing the security they dreamt of. Retirees are being forced to spend their children’s inheritance or go back into debt just to meet living costs.
So there has been a rise in the sale of reverse-mortgage products. A reverse mortgage basically allows you to borrow cash against the value of your home.
To be eligible for one you need to own your own home and generally be over the age of 60. Depending on your age, you can borrow between 15 and 40 per cent of your home’s value. The older you are, the more you can borrow. You usually do not need to make regular repayments as you would with a conventional home loan. Instead, you pay back the value of the loan once you sell the home, move into care or die.
Each year the fees and interest are added to the original loan and interest compounds year after year (interest is charged on the interest). So, unlike a conventional loan that reduces over time, with a reverse mortgage the debt grows. A reverse mortgage allows you to access cash either in a lump sum or as a continuous income stream or a combination of both. You don’t need to have an income to qualify for a reverse mortgage, and the best advantage is that you can remain in your own home and retain ownership of it.
But there are downsides to consider.
Interest rates on reverse mortgages are often higher than on conventional home loans. Couple this with the fact that the interest is compounding over the term of the loan, and the cost of the loan is not only unknown but can be very high. There is even the risk that the compounding interest effect could lead to the loan being greater than the value of the home. This would leave you in a negative equity position. If considering a reverse mortgage, ensure it contains a no negative equity guarantee clause that protects you from having to pay any shortfall. Some products also offer the option to protect a fixed percentage of the value of your home that cannot be used to repay the loan.
Remaining in your own home might seem like a great idea while you are still fit and healthy, but you may not always be that way. As you age, you may find the upkeep of your home onerous. Reverse-mortgage agreements often require the owner to maintain the property to a certain standard. If you are unable to do this, you may find you lose your no-equity guarantee or the lender may have the right to evict you.
A reverse mortgage may also affect your eligibility for a pension if you take the loan as a lump sum. While your principal family home is excluded from the pension asset test, if you use the loan funds to invest in shares or buy a car, these assets may be included in the test and this may also reduce the pension you are eligible to receive.
As you have no idea how long you are going to live, there is no way of knowing how big the loan will eventually be. You may find that it has increased so much that there is not enough equity left in your house to fund aged care or leave your children an inheritance.
There are some reverse mortgages that allow you to borrow for a fixed term, but you then run the risk that the term expires before you die or are ready to move into care and you have to sell the house anyway to repay it.
If you are the sole owner of the home, the loan will only be in your name. If you live with a spouse or partner, they may be evicted if you die or move into care, so that the house can be sold to repay the loan.
So if you are considering a reverse mortgage, establish how much cash you need, be conservative about the value of your home and its potential growth and establish how long you think you will live. Will you need aged care and do you want to leave an inheritance for your kids? Most importantly, get sound legal advice to ensure you understand what you are getting into.
Alternatively, you can always sell your home, move somewhere smaller and enjoy the fruits of your hard-earned cash while you still can. After all, you won’t be around to enjoy the inheritance you leave behind.
Caroline Elliott BEc. CA
Financial and commercial consultant
c.elliott@eftel.com.au
The financial advice offered here is generic.