For some senior Australians, unlocking the equity built up in their home using a reverse mortgage is becoming an alternative to reliance on pensions or superannuation. Reverse mortgages is the opposite of a traditional mortgage: you use equity in your home as a line of credit, paid to you in instalments or a lump sum.
Reverse mortgages don’t require repayments immediately. The lender is paid back after you sell the home or pass away.
The major difference between regular mortgages and reverse mortgages is that interest is compounded. Compound interest is essentially “interest on interest” that can add quickly. Compound interest can erode the equity in your home more quickly instead of using that equity to purchase tangible assets such as other properties, for example.
There are many moving parts to reverse mortgages such as housing market growth rates, interest rates, and how much a borrower chooses to take out their reverse mortgage; either in instalments or in lump sums.
Who takes out reverse mortgages?
According to an ASIC report into reverse mortgages published in August 2019, 70% of Australians aged 55-85 own their own home and have a collective $500 billion in home equity (over the age of 65).
Reverse mortgages are aimed at retirees looking to bolster their retirement cash flow. Though the lure of unlocking money from something you already own seems promising, it can lead to financial difficulty later down the road.
Only two financial institutions hold over 80% of all reverse mortgages. After a 7:30 expose and findings the Royal Commission into the financial services sector over 2018-19, Commonwealth Bank, BankWest, Westpac, and Macquarie Banks all ceased offering reverse mortgages.
As a result, ASIC is attempting to enforce stricter rules around reverse mortgages to ensure consumers are better protected.
What happens over time?
As reverse mortgage interest is compounded over time, retirees may have less wealth over time as they anticipated.
According to ASIC, after a 15-year reverse mortgage at the average loan rate - $118,627 - the interest payable could total near $200,000.
The interest (set at 7% p.a. in the next example) is theoretically offset by an appreciation in housing prices. However, if one’s starting equity at age 65 is about $500,000 and takes a $100,000 lump sum and the housing market does not experience growth the borrower may have below 50% equity at $231,142 15 years later.
Assuming a 5% growth rate and a $100,000 lump sum paid out, the projected owner’s equity will remain at $770,606. Fluctuations in the market such as increases in interest rates and decreases in house prices means such rosy outlooks could be less likely.
|Growth rate||Equity remaining after 15 years|
The ASIC report also suggests that up to 63% of borrowers may end up with less equity than the average upfront cost of aged care for one person by the time they reach age 84.
A government backed option
The Federal Government offers a loan scheme known as the Pension Loan Scheme that uses a reverse mortgage as the basis for boosting one’s pension payments.
Pensioners can get a boost of 50% with a fixed interest – not compound interest rate – of 5.25% p.a. This gives couples an extra $17,800 p.a. or singles $11,800 p.a.