What is a reverse mortgage?

If you don’t have a steady source of income, whether on account of your age or due to any other reason, your options for borrowing debt from the market are limited.

However, those who own a house in Australia can monetise their equity and borrow a loan without selling or vacating the house. Such a loan is known as a reverse mortgage, as the borrower receives monthly payments from the lender in lieu of offering the home equity.

Here’s everything you need to know about reverse mortgages:

Simply put, a reverse mortgage is a type of loan where you borrow money from reverse mortgage lenders by offering the equity you have in your home as security. It is one of the options available for borrowers over 60 years.

In other words, a reverse mortgage converts the existing home equity into cash. The loan amount can be used for several end uses, such as paying for living costs or medical expenses.

There are three types of reverse equity mortgages in the market:

Single-purpose reverse mortgage

Government agencies, private banks, and financial institutions provide reverse mortgage loans that are only meant for a single purpose.

For instance, the lender may specify that the loan proceeds can be only used for carrying out renovations or home improvements. The funds cannot be utilised elsewhere. Since this option costs the least, it is preferred by more borrowers.

Proprietary reverse mortgage

Typically, only private lenders offer this type of reverse mortgage. It comes with more flexibility than single-purpose mortgages, as there are no restrictions on how you can spend the loan proceeds.

It is a great home loan for seniors who want to borrow a significant amount of money and also live in high-value houses.

Home equity access loan

Such loan arrangements from the Australian government allow elderly homeowners to borrow against the equity they hold in the house in Australia. The loan repayment is secured through a mortgage over the house and deferred until the house is sold.

Usually, you must be at least 60 years old to be eligible for a home equity conversion loan though borrowers below the age of 60 years can also consider applying. The amount you can borrow depends on whether you receive a pension or not.

So which banks offer reverse mortgages in Australia? Almost all leading banks and financial institutions offer reverse mortgages for seniors.

Before you commit to a reverse equity mortgage, here’s a breakdown of the pros and cons:

Benefits

• It allows senior citizens to continue staying in the house as long as they want and also borrow against their equity.
• It can provide cash flow and allow retirees to enjoy a stress-free life.
• The lump sum amount received from a reverse mortgage can help you retire earlier than planned.
• Existing home loans, if any, can be paid off by the reverse mortgage lender. This can relieve the stress of being a debtor for multiple debts for the same property.
• Reverse mortgages in Australia enjoy protection under the National Consumer Credit Protection Act 2009. As a result, you enjoy a guaranteed lifetime occupancy and cannot be forced out of your house as long as you fulfil the loan obligations.
• The National Consumer Protection Act 2009 also provides for no negative equity guarantee. It means that when the reverse mortgage ends, the total amount you owe to the lender cannot be more than the value of your home.

Drawbacks

• The interest rate charged is higher compared to traditional home loans. In fact, most reverse mortgages are structured with variable interest rates, which fluctuate throughout the life of the loan.
• Except for a home equity access loan, the interest on a reverse mortgage can’t be deducted from your tax liability till it is paid in full.
• With time, a reverse mortgage drains the equity from your property which diminishes the asset value equity of your home, resulting in a lower asset value for you and your heirs.
• There are various costs associated with a reverse mortgage, in addition to the reverse mortgage interest rate. These include an origination fee, servicing fees, third-party fees, and insurance premiums and can quickly add up to increase the overall cost of borrowing.
• Depending on the condition of your house, you may have to carry out extensive repairs before applying for a reverse mortgage. This can mean an additional financial burden.

In simple words, a reverse mortgage permits the borrower to use the equity they have in their house and borrow a loan against it.

Unlike a traditional home loan, where the borrower has an obligation to pay monthly instalments to repay the loan, the reverse mortgage lender makes payments to the borrower instead of receiving equity of the property. The borrower continues staying in their house. If the house is sold upon the borrower’s death or other residents move out of the house, the loan amount must be paid back along with fees and interest.

Lenders must follow all rules of responsible lending when approving a reverse mortgage for senior citizens. Typically, the older the borrower gets, the higher the proportion of equity -- if you are 60 years old, you can expect a loan amount worth 15 to 20 percent of the property value, and it increases by one percent as you get older.

The total cost of a reverse mortgage loan depends on several factors, such as:

• The amount borrowed
• The manner in which you borrow it (whether it is a lump sum amount or monthly payments)
• The tenure of the mortgage
• Various upfront costs associated with a reverse home mortgage, such as origination fees, closing costs, and a mortgage insurance premium to guarantee that you will get the loan amount.
• Mortgage reversal also carries ongoing costs such as the interest payable annually, service fee payable for the life of the loan, applicable property taxes, and annual mortgage insurance premium. What is the interest rate on a reverse mortgage currently? It is difficult to pinpoint a single figure as it varies depending on the lender and your financial background.

Moreover, unlike traditional mortgages, the cost of a reverse mortgage compounds over time. To get an accurate representation of reverse mortgage calculations and understand the true impact of taking out the mortgage on your home equity, make sure to use online calculators available or speak to your broker.

This type of mortgage can work very well for borrowers who have valuable assets but do not have sufficient liquidity.

That’s why a reverse home mortgage for seniors is considered a great financial arrangement, as many people aged 60 and above have equity in their homes which can be leveraged for borrowing funds. Instead of opting for traditional loans, where repayment can become an issue without a steady source of income, such specialised home loans for elderly are a better option.

Nevertheless, reverse mortgages are a debt you owe to a lender that needs to be paid off with interest and costs. Since the reverse mortgage rates vary greatly, don’t forget to do your diligence before you sign on the dotted line.

Moreover, for senior citizens, a reverse mortgage also directly impacts their ability to pay for aged care and future expenses and how much they leave behind for their loved ones once they pass. So make sure to consider all your options before you sign up for one.

There are various reasons you can leverage your home's equity and borrow against it. These include:

• Refinance home loan
• Purchase a new car
• Provide financial assistance to kids to buy their first home
• Get a regular income
• Pay for unexpected medical expenses
• Pay for assisted living or caregiving facilities

Not everyone can take out a reverse mortgage even though they may own a home. In order to qualify for reverse mortgage services, one must fulfil the age requirement specified by the lender and also hold equity in the home, which is their principal residence or where they spend the majority of the time in a year.

Ideally, the homeownership should be without any encumbrance or pending mortgage. In case you are yet to pay off the mortgage, you can use the proceeds of the reverse mortgage towards that. And lastly, your home should be a good shape to qualify for a reverse mortgage creation. If it fails to meet the specified property standards, the lender may ask you to do extensive repair work.

The lenders have strict lending limits when it comes to a reverse mortgage. The amount is linked to the equity you hold in your home. Typically, the best reverse mortgage companies allow borrowers aged 60 and above to borrow approximately 15 to 20 percent of the home value and an additional one percent every year thereafter. For instance, if your home is valued at $2 million, you can initially expect to borrow somewhere between $300,000 to $400,000 through a reverse mortgage.

The limits are put in place to make sure that your home equity is not completely eroded by the time the mortgage comes to an end. In most cases, $10,000 is the minimum amount you can borrow from the best reverse mortgage lenders in Australia.

The reverse mortgage requirements vary depending on the lender you are approaching. Typically, reverse mortgage providers specify the following conditions to approve a loan application:

• The borrower should be within the age group of at least 60-65 years though others can also apply
• A prior home loan should be paid off in full primary home and investment properties, if any, should be free of encumbrances and available for being pledged as security
• Property should be located in an eligible zip code as specified by the lender
• The homeowner should be an Australian citizen or have a Permanent Resident status

Some lenders may specify a minimum property value to provide a reverse mortgage loan against it. In most cases, lenders do not specify income criteria as long as borrowers fulfil the other conditions. Make sure to confirm your eligibility using a reverse mortgage eligibility calculator before applying.

In the case of a Home Equity Access Scheme loan, one must fulfill all the requirements below:

• You should be eligible to get a pension from Centrelink
• You should own real estate in Australia
• You shouldn’t be bankrupt or be named in any insolvency agreement
• You should have adequate insurance to protect your real estate, which is offered for the reverse mortgage

Usually, credit scores are not considered for evaluating reverse mortgage loan applications. If you are ineligible to borrow a reverse mortgage and have a bad credit score, consider speaking to your lender about bad credit home loans. You can also explore whether you can get pre-approved for a home loan to improve your chances of securing approval.

And what’s the minimum credit score for a home loan? It depends on the lender you are applying to since different lenders rely on scores from different credit scoring agencies.

Whether a reverse mortgage is the right option for you boils down to your eligibility and how you plan to use the proceeds. As pensioners and self-funded retirees, there are some government-backed schemes you can consider as home loans for seniors. And if you are not a senior but own a home, you can still monetise the equity to borrow against it.

In any case, always undertake a thorough cost-benefit analysis before taking on any form of financial liability.

Before you apply for any reverse mortgage, make sure to check your credit score to better understand your eligibility. To know what’s your current score, sign up with ClearScore to check credit score and get free credit report.