Reverse Mortgages
Reverse Mortgage loans have three defining characteristics:
1. No mandatory payments are required until a trigger event occurs. Trigger events can include death of the owner/s, sale of the property, moving out, or breach of certain clauses of the contract.
2. There is generally no set or fixed term. These products last until the surviving signatory dies or a trigger event occurs.
3. Interest is charged and compounded over the life of the loan.
Applicants who qualify can borrow up to limited amounts of money against the security of their primary residence. In some cases these loans may be secured against non-owner occupied properties.
While this type of loan can never be in default due to lack of payments being made, other conditions of the loan can place it in default. These include not maintaining the property to a satisfactory standard. In this case the lender may have the right to have the maintenance done with the cost being added to the balance of the loan.
Eligibility
To qualify, applicants must be of a minimum age - commonly 60 years. Where there is more than one borrower, the age of the youngest person determines their eligibility. The amount of the loan available varies depending on the provider. The basis for calculating the amount borrowed firstly depends on the age of the applicant. Generally the older the applicant the more they can borrow.
Secondly, the value of the property determines the maximum size of the loan. The Loan to Valuation Ratio (LVR) is the amount advanced against the value of the security property. The maximum LVR can be as a high as 50%.
The minimum loan amount depends on the provider. It can be as little as $10,000 or any other specified amount. Applicants must own the property. If there is an existing mortgage on this property it must be repaid in full. This allows the reverse mortgage provider to have the only mortgage over the secured property.
It is usually necessary to have the property revalued on a periodic basis. The cost of this may be borne by the consumer or added, at the time of valuation, to the loan.
In some cases, providers may restrict the eligibility of the borrower based on the location of the secured property.
Compound Interest and Other Costs
The interest rate charged is usually just above the market’s standard variable rate. It is generally accrued daily and then charged monthly (compounded), therefore the debt increases over time. Refer to NICRI’s Reverse Mortgage Calculator.
Where a person borrows $30,000 gross (including an application fee), with an interest rate of 8.5% and a monthly charge of $10, at the end of 10 years the debt would have grown to about $71,860. This assumes the interest rate remains constant – a big assumption as usually a variable interest rate applies.
Other costs such as an application fee and monthly account fees can also apply. These are usually added to the loan and are also subject to compound interest.
If desired, it is possible to make voluntary repayments which will effectively reduce the amount of debt that accrues. Other assumptions that need to be made could include the potential value of the property over time and the cost of maintenance. These can be particularly important where it is the borrowers desire to leave a legacy.
It is sometimes possible to have a protected amount of equity which can be left as a legacy. This will restrict the amount that can be borrowed. Applicants should check the terms and conditions of this option with their provider.
Prior to making an application for a loan it is important to check if an application or establishment fee is payable even if the loan is not proceeded with.
Choices and Options
Income Stream vs Lump Sum
There are different ways you can receive the funds such as a lump sum, a line of credit or regular income. Or you can opt for a combination of these. There are pros and cons associated with each approach. Whichever option you choose, you should discuss your choice carefully with a qualified professional (see section ‘Getting Advice’). The amount you borrow – and the way you choose to receive it – could affect many other things in your life, such as social security benefits. (See section 3 ‘Impacts on Your Pension’).
If you would prefer a regular income, there are a couple of ways to set this up. Some reverse mortgage lenders offer their own line of credit. Once you’ve set up the loan with them, they will see to it that you receive regular income payments.
Depending on how the regular income plan is structured, you might simply receive small, regular drawdowns of your loan principal. In this case, there will generally be no effect on your Government Income Support entitlements. You have the flexibility of having money when you need it and, as mentioned you will not be charged interest on money you are not yet using.
Besides the Government Income Support treatment, a further advantage of this is you don’t start to accrue interest on your loan until you actually draw down the funds.
Fixed vs Variable
You may also have a choice between a fixed or variable rate loan. A fixed rate loan may offer you peace of mind that the interest being charged cannot move up or down. This option may be attractive if you are able to fix the rate before interest rates rise but not so attractive if interest rates are falling. A variable interest rate will move up and down according to Reserve Bank interest rate movements and therefore are subject to rises and falls.
Care should be taken on fixed rate loans as there may be a limit on the repayments and a penalty may apply. Be sure to check with the provider on the details.
No Negative Equity
Some providers offer a ‘no negative equity guarantee’. This means that if the balance of the loan exceeds the proceeds of sale of the property, no claim for this excess will be made against the estate or other beneficiaries of the borrower. It is important the contract be examined thoroughly as this guarantee may be subject to certain conditions.
Equity Protection Option
Another option is to quarantine an amount of equity you wish to keep as a legacy. There is usually no fee for this option however it may reduce the maximum amount you can borrow.
Increasing the Borrowing in the Future
NICRI has had enquiries from people who have not needed the total amount they were borrowing at the time but who were contemplating borrowing a larger sum of money to avoid having to apply for a loan increase at a future time.
The main concern with this course of action is if the borrower does not need the extra money but uses the funds anyway which results in a much higher debt at the end of the loan. This of course reduces the remaining equity in the property which for some is an important concern.
The benefits in following this course of action is if there is a change in the policy of the lending institution, the loan is already approved. There is also the convenience of not having to apply for the increase at a later time, possibly avoiding extra application fees.
In this situation it would be prudent to calculate the costs that could accrue if additional funds were borrowed initially compared with increasing the amount of the loan at a time when the funds were required. Where the loan amount is to be increased in the future a further application fee usually applies. For example, if $30,000 was borrowed and retained for 2 years, assuming a borrowing interest rate of 8.5% the interest accrued on the unused funds would be about $5,538 (including compounding). Assuming the funds were invested at 5% and neither tax nor reduction in government income support applied, the cost over 2 years would be $2,538.
This is because of the extra interest accrued on the larger amount borrowed. Provided the application fee remains stable applying for the additional borrowing later may be cheaper.
Other options include having the approval for the higher amount but not drawing the funds until they are required. In practice, many people who have this option do not exercise self control and spend the additional amounts sooner than they intended.
