Reverse mortgages explained

A number of lenders now offer “reverse mortgage” loans for retired people who own their own home but have little cash to live on. They are termed “reverse mortgages” because instead of borrowing money to buy a home, borrowers are using the home that they already own to secure borrowing to spend elsewhere. This style of loan allows the ‘cash poor, asset rich' to create a cash flow out of the equity built up in their home, without having to sell it.

The beauty of the arrangement is that you can generate money to live on and still remain in your house. No repayments are required during the loan term with the total interest, fees and charges being taken out of the estate on the borrower's death or sale of the home when they decide to move.

Being able to tap into the equity in your home allows you to purchase goods you may have had to do without through lack of funds. For example, a new car, holiday or even to pay for house repairs. This is especially beneficial if you do not have many assets outside the family home to draw on to pay for these. However, there are plenty of issues to consider before you decide to sign up.

Eroding the value of your home

While the concept of a reverse mortgage is tempting they are not for everyone. Although borrowings are limited to a small proportion of the overall value of the home, borrowers should realise that unless the rate of growth in property values is high, the borrower will see their equity in the asset being eroded each year, leaving less available to pass on in their will.

Interest is capitalised onto the loan and builds up each year so that eventually the debt amounts to a lot more than the original loan. For example, someone borrowing $100,000 at 8 per cent will owe $220,000 in interest and principal after 10 years, plus any fees. While repayment is not required by the borrower while they remain alive and living in the home, it must be repaid eventually, usually out of the estate upon death.

What about the children?

One thing to consider – if it is important to you – is that you will have fewer assets to leave to your children. Unless you sell your property and pay back the loan prior to your death, the beneficiaries of your will may be left with a property that has an outstanding loan secured against it. This may come as a shock if it wasn't expected, and your beneficiaries may find it difficult to deal with this as well as the grief of your death.

Published: 20 September 2005