Reverse mortgages - useful, but be aware of the risks
HOLIDAY periods like Easter can be challenging for some retirees, who want to lavish treats on their grandkids even if it means scrimping on personal spending to get by financially. A reverse mortgage can provide welcome extra cash for seniors though it's an option that should be carefully considered.
Reverse mortgages are available to home owners aged over 55. It's a loan that lets you borrow against the value of your home, and unlike a traditional mortgage, no regular repayments are required. The loan plus accumulated interest is paid off when the home is sold, either through the owner dying, moving into a nursing home or aged-care facility, or simply downsizing.
The funds from a reverse mortgage can be taken as a lump sum or as a series of regular payments, and you're free to spend the money as you choose. It all sounds very tempting for asset-rich, cash poor retirees. But there are downsides.
A significant issue is the risk of prematurely exhausting your home equity - something that may be needed to fund aged care accommodation in the future.
To help retirees assess this risk, the government's MoneySmart website (www.moneysmart.gov.au) recently launched a new reverse mortgage calculator. It provides a chance to test any number of 'what if?' scenarios to see how your home equity could be affected by changes in interest rates and house prices in the years ahead.
Let's use an example to see how the numbers can stack up. We'll say Robyn and Ted are a retired couple both aged 65. Their home is worth $600,000 and they decide to use a reverse mortgage, taking out $25,000 annually in regular payments over five years at an interest rate of 10%. We'll also assume their home grows in value by 3% annually.
By the time Robyn and Ted reach age 75, their loan payments plus the mounting interest bill will have pushed their home equity down to $535,961. By age 80 they will have $499,316 remaining in equity, and if they live to age 92 they could exhaust their home equity altogether.
It's a scary scenario but despite the impact on home equity, a reverse mortgage is undoubtedly a far better option than living in retirement on a hand to mouth existence. And there are ways to minimse the pitfalls of a reverse mortgage.
First, be wary of borrowing the maximum available amount. Leave some spare borrowing capacity in case you need it later on.
Check the loan costs you're paying because in addition to a reverse mortgage having higher interest rates than normal home loans, they can also come with solid fees and charges.
Importantly, look for a lender that offers a 'no negative equity' guarantee. It means that if the value of your loan exceeds your home equity, the lender wears the loss.
Always seek trusted, independent financial advice on reverse mortgages, and never sign a contract for one without first consulting a solicitor. Such a loan has significant ramifications about which you need legal advice.
It's also worth speaking to Centrelink to see if payments from a reverse mortgage could affect your age pension entitlements.
Paul Clitheroe is a founding director of financial planning firm ipac, chairman of the Australian Government Financial Literacy Board and chief commentator for Money magazine. Visit www.paulsmoney.com.au for more information.