Reverse Mortgages: Understanding How They Work and Their Risks

---

For people contemplating how to fund their retirement, accrued personal savings, accumulated superannuation, and, if eligible, the aged pension generally first come to mind. However, with the number of retirees increasing markedly and predictions that people will live longer in retirement than ever before, many existing retirees are now considering the benefits of a reverse mortgage to unlock the equity in their home. While this financial strategy can provide significant advantages, it's essential to also understand the potential reverse mortgage risks. Additionally, consulting with an elder law expert can help ensure that you make informed decisions regarding your retirement funding options.

A reverse mortgage is a type of home loan that allows you to borrow money by leveraging the existing equity in your home as collateral for the loan. Depending on your lender, you can choose to receive the funds as a lump sum, a regular income stream, a line of credit, or a combination of these options. Understanding the reverse mortgage benefits can help you make an informed decision about your financial future. 

Like other loans, interest is charged on the outstanding balance; however, you don’t have to make any interest or principal repayments while you reside in your home. The unpaid interest compounds and is added to your loan balance. 

As you remain the full owner of your home, you can live there for as long as you wish, but you will need to repay the loan in full when you sell your home, pass away, or if you transition into aged care. Generally, you must be at least 60 years old to apply for a reverse mortgage. While lenders typically do not impose an income test for qualification, you will need to pay an application fee. It is also important to consider the reverse mortgage risks involved, as they can impact your estate planning and elder law considerations.

Interestingly, with a reverse mortgage, the older you are, the more you can typically borrow. While different lenders have varying policies on the amount available, as a general guide, if you are aged 60, the maximum amount you can borrow is likely to be 15 – 20% of the value of your home. As a rule of thumb, you can usually add one percent for every year that you are older than 60. For instance, if you are 75, the maximum amount you can generally borrow would be 30 – 35% of your home's value. Understanding the reverse mortgage benefits is essential, but it's also crucial to be aware of the reverse mortgage risks involved. Additionally, if you have an existing mortgage on your property, it is a requirement of your lender that you discharge the amount owed on that mortgage from the proceeds of the loan advanced under the new reverse mortgage, which is a key consideration in elder law.

When considering a Reverse Mortgage, there are several important factors to keep in mind, especially in relation to elder law. First, interest rates for Reverse Mortgages tend to be higher than average home loans, often reaching 2% – 3% above standard home loan rates. This can lead to significant reverse mortgage risks, as the amount owed can increase quickly due to compounding interest over the loan's term. Consequently, you may find that you have insufficient funds for future needs, such as securing a place in an aged care facility, when your circumstances require selling your home. Additionally, anyone residing in your home who is not a co-owner may have to move out upon your death. Lastly, if you decide to fix your interest rate when obtaining a Reverse Mortgage, be aware that the costs associated with breaking this agreement can be prohibitively high.

Under current legislation, it is mandatory for your lender to provide you with a document known as a “Reverse Mortgage Information Statement.” This statement must include details about how your Reverse Mortgage works, how the lender’s costs are calculated, and important factors to consider before taking a Reverse Mortgage. Additionally, it provides contact details for further information regarding elder law and the implications of such financial decisions.

Your lender is also required to show you the long-term impact that a Reverse Mortgage will have on the equity in your home. They will do this by meeting with you to run through prospective Reverse Mortgage calculations using an approved Reverse Mortgage Calculator. These projections will illustrate the effect that a Reverse Mortgage may have on your home equity over time, considering various scenarios related to different interest rates and housing price movements.

It's crucial to be aware of the reverse mortgage risks involved. Borrowers under Reverse Mortgages are protected by a Negative Equity Protection, which has been mandated for all Reverse Mortgage Product Contracts entered into after September 2012. This means you can never owe your lender more than your home is worth when it is sold. Accordingly, the maximum your lender will receive is the total proceeds from the sale of the property, and you cannot be held liable for any debt amount exceeding this. For this scenario to arise, a significant increase in interest rates or a substantial downturn in the housing market impacting property prices would be necessary.

The answer to this question largely depends on how you take the Reverse Mortgage loan advance and what you plan to use it for. According to current Centrelink rules, if you draw a lump sum from a Reverse Mortgage, up to $40,000.00 is exempt from the Pension Assets test for up to 90 days. However, it is immediately subject to deeming under the Income Test until you spend the money. Understanding these nuances is crucial, especially in the context of elder law, as they can significantly impact your pension status.

How you choose to spend the money will also determine whether your pension is affected. For example, if you decide to purchase a new car or caravan, these may be considered assets and included in the assessment of your pension entitlements under the Assets Test. On the other hand, if you utilize the loan advance for home renovations, repairs, or a holiday, this expenditure is not means tested, and therefore your pension would remain unaffected. This highlights some of the reverse mortgage benefits and risks that borrowers should carefully consider.

If you are considering entering into a Reverse Mortgage, there are several avenues to obtain advice. You might start by contacting us for independent legal advice, which is particularly important given the elder law implications. Discussing your intentions with family members, especially your adult children, can also be beneficial, as they may propose alternative financial solutions. Additionally, speaking with your accountant or financial advisor can help you explore other options, taking into account your current savings and investments. It’s also wise to contact Centrelink to fully understand how a Reverse Mortgage may impact your current pension entitlements. Furthermore, you can access the Reverse Mortgage calculator on the Australian Government website www.moneysmart.gov.au to evaluate how different loan terms, property values, and interest rates could affect the equity in your property. 

While there is no shortage of marketing material aimed at convincing older Australians to cash in on their home equity, it’s crucial to carefully weigh the reverse mortgage risks and benefits. Taking out a Reverse Mortgage can be a viable option, but ensure you consider the potential ramifications on your later years of retirement and seek appropriate independent advice.