By Andrew Young, Associate, Slater & Gordon Lawyers
A reverse mortgage is a complex financial product which you shouldn’t rush into. And they’re on the rise - a recent comprehensive study of the Australian reverse mortgage sector by Deloitte Actuaries and Consultants found a total of $3 billion outstanding under 41,600 reverse mortgage loans, up 11% from December 2009.
A reverse mortgage might seem like an appealing option now, but in later years it can seriously impact your financial situation and quality of life. Before signing anything, make sure you fully understand your rights and obligations and obtain independent financial and legal advice.
Here are some important initial considerations:
What is a reverse mortgage and how does it work?
A reverse mortgage allows you to borrow money using the equity in your home as security for the loan. Generally available to those aged 60 or over, they are sometimes called ‘equity release’, ‘equity unlock’ loans or similar names. The borrowings can be taken as a lump sum, income stream or line of credit. Interest is charged but you don’t need to make repayments while you live in your home. Instead the interest is added to your loan balance. The loan, interest and any fees must be repaid in full when you sell your home, die or move into aged care.
Due to the lack of upfront repayments a reverse mortgage can appear a very attractive option to those seeking to supplement their retirement income or pay for one-off expenses like home renovations.
But there may be a sting in the tail.
What are the risks?
Because the interest repayments are added to your loan you end up paying interest on interest and any fees and charges. In other words, the interest compounds and your total debt, even on modest initial borrowings, can grow very quickly. To make things worse, interest rates for reverse mortgages tend to be higher than normal home loans.
Your total debt could even surpass the value of your home leaving you in a “negative equity” position. This means the sale proceeds of your home would be insufficient to repay the loan and you, or your estate, would need to find other funds to make up the difference. Thankfully, many lenders include a “No Negative Equity Guarantee” (NNEG) as part of their reverse mortgage product so you are not required to pay more than the realisable value of your home to discharge the mortgage. Be careful though, because the terms of NNEGs can vary and the protection can be lost for seemingly minor breaches of the terms.
Mounting debts under a reverse mortgage may also significantly affect your future ability to afford major medical expenses or a bond for an aged care facility. Consider all of your future needs before proceeding.
The reverse mortgage will likely require you to meet certain ongoing obligations such as having your home revalued (at your expense) every few years, maintaining it to a certain standard and promptly notifying the lender of significant events such as intended vacation of the property.
The loan may also affect your eligibility to receive pensions. Because of the variable circumstances independent financial advice is essential so you understand the implications. Although it does not give advice, a good starting point is contacting Centrelink’s Financial Information Service.
On a more personal level, a reverse mortgage depletes your estate assets and may result in disappointment or tension with family members who might have certain inheritance expectations. It is a good idea to discuss your plans with your family before taking any action.
What can you do to protect yourself?
In our experience as lawyers and daily litigators, prevention is far better than a cure. Before agreeing to a reverse mortgage make sure you fully understand what is involved, the terms and conditions of the loan and the implications for you on a legal, financial and personal level.
Get independent financial and legal advice. There may well be other financial arrangements which are more suitable and less risky – for example, borrowing from family or selling and downsizing. Engage an experienced lawyer to advise you on the fine print of the mortgage terms so you can make a fully informed decision before you commit. If you go ahead with the reverse mortgage and things do go wrong, a lawyer can also advise you of possible avenues to obtain compensation or other relief.
Don’t be embarrassed to ask a torrent of questions to the proposed lender and any professional adviser. After all, it’s your money and your future quality of life you are dealing with.
Five ‘must ask’ questions:
1) How much is this loan ultimately going to cost me? ASIC’s Moneysmart website (www.moneysmart.gov.au) has a reverse mortgage calculator which can give you an indication of the compounding effect of interest over time.
2) Does the proposed reverse mortgage have a No Negative Equity Guarantee and if so, how can that Guarantee be lost?
3) Has the proposed loan been structured so I will always have sufficient funds for future expenses such as medical bills or a deposit for aged care? How could it affect my pension (if any)?
4) Have I had all the terms and conditions explained to me in plain English and do I understand them?
5) Is a reverse mortgage the best choice for me or are there other options?
This article appeared in the February/March 2012 issue of 50 Something Magazine