Money

The pros and cons of a reverse mortgage: we run the scenarios

Many retirees who’ve paid off their home find themselves asset rich, but cash poor. Is tapping into your home equity through a reverse mortgage a good solution?

By Nicole Pedersen-McKinnon

In retirement, you may find yourself happily asset rich – with a lovely big home you call your own – but cash poor. Because without a salary, those costs (even just the housing ones) can be harder to cover.

Recently, the federal government’s Retirement Income Review declared equity in the home an untapped solvency solution Aussies can ‘tap into’.

One way to do this is with a reverse mortgage.

A mortgage without repayments

Available once you hit 60, these really are like a mortgage in reverse… you get the money but don’t make repayments.

Instead, the debt rolls up and is repaid from the eventual sale of your home by you or your estate (or sometimes by other means), down the track.

You do a deal with a bank or financial institution to exchange an original amount of equity for a lump sum, regular income, line of credit, or a combination – for living on, repairing your home or even funding aged care.

The amount of equity will depend on your home’s value and your age – the proportion you can borrow of your home’s value actually increases as you get older, by perhaps 1 percentage point for each year over age 60 (more on this in a moment).

Your equity decreases while the bank’s grows

The thing to remember is that with a reverse mortgage the equity that a bank or institution owns will grow. And that means the equity you hold decreases over time.

Rest assured, your debt can’t grow beyond the value of your home – a no-negative-equity guarantee has been law since 2012. But, if house price growth falls far behind higher-than-normal interest rates, your reverse mortgage debt will grow significantly over time.

Here are examples of how this could look – and note that a prospective reverse mortgage provider must give you these projections of your personal situation in different scenarios.

Here’s what you could own and owe

Let’s first look at a reverse mortgage taken out at age 70 on a $700,000 home, for the typical maximum in those circumstances: $210,000 (or 30%, although the minimum is often just 3%, $20,000 in this case).

Our modelling assumes house price growth of 3% and a reverse mortgage interest rate of 8%.

$210,000 taken at age 70 (from $700,000 home)

You can see that in 15 years’ time, by age 85, your house would be worth $1,090,577 and the original $210,000 loan would have grown to $689,854, with home equity you still own of $400,723.

That means the initially 30% loan will have become 63%. You will run out of all equity at age 95.

Take out less than the maximum and your debt will, of course, not forge so high by 85.

$100,000 taken at age 70 (from $700,000 home)

So you can see that if you just take out $100,000 at age 70, by 85 the lender will only own 30% of your home (instead of 63% if you took $210,000), with a loan owing of $328,502. The equity in your home disappears only when you are 109 years old.

Of course, $100,000 might disappear quickly, too.

The same applies if you wait longer before taking out the loan - taking the loan from age 75 instead of at age 70.

$210,000 taken at age 75 (from $700,000 home)

Holding out that extra 5 years for $210,000 also preserves a bit of equity.

In this case, the lender would only own 49% (instead of 63%) by age 85 and you would have a debt of $463,038 (against a home that has grown over this-time 10 years to $940,741. The equity in your home might reach $0 by the time you are 100 years old.

$210,000 taken from age 70 – in instalments (from $700,000 home)

You could slash the speed of equity loss dramatically by taking not a lump sum of $210,000, but monthly instalments from age 70 until that amount is exhausted.

A monthly $1166 for 15 years until 85 totals $210,000. Here, you give up 37% by the time you are that old (instead of 63% if you took the lump sum), with a debt of $403,481. The equity in your home might reach $0 when you are 105 years old.

How a booming property market helps a reverse mortgage

How might the good luck of a roaring property market help? Let’s go back to our original example of the maximum $210,000 loan taken at age 70 from a $700,000 home.

This time, ignoring fees and charges (guaranteed there will be some), a reverse mortgage interest rate of 8% and property price growth of 8% (almost) cancel each other out: the percentage of equity you own (70%) and owe (30%) will stay virtually the same over time (with a lump sum payment).

$210,000 taken in a booming property market… at age 70 (from $700,000 home)

This first, base scenario on the left of the projection below, tells this story over 15 years, to age 85. Then the custom scenario on the right depicts the difference if house prices instead push an average 12% high.

You can see you go from almost level equity – 69% – to actually having that equity grow… to 82%.

And that’s why the pricing of a reverse mortgage, and the property market in which you take it out, are key.

Other considerations

It’s also important to keep in mind that taking out a reverse mortgage can affect your eligibility for the Age Pension - up to $40,000 is exempt from the assets test for up to 90 days if you draw a lump sum from a reverse mortgage. However, it is immediately subject to deeming by the income test until you spend it.

But the good news is, payments from a reverse mortgage aren’t taxable, because they are loans borrowed against the value of your home.

^{Advice given in this article is general in nature and does not take into account your personal circumstances. It is not intended to influence readers' decisions about investing or financial products. They should always seek their own professional advice that takes into account their own personal circumstances before making any financial decisions.}