Reverse Mortgages - do they stack up?
A mortgage loan, secured over a residential property, that is typically available to older homeowners over the age of 60.
It enables access to funding using the unencumbered value of a property. The credit provider does not mandate regular loan repayments. Rather, interest is calculated on the balance outstanding, and added or "capitalised" to the loan on a monthly basis.
As the loan balance generally goes up over time, the starting LVR ("Loan to Value Ratio") is much lower than a traditional home loan. This is capped at around 40% of the property's independent valuation.
Features & Access Options
RM's usually offer multiple draw-down options, including a lump sum advance, regular advance or a reserve facility.
In most cases, loan repayments can be made any time or the loan paid off in full without any penalties.
The mortgage must be discharged when the last borrower moves permanently from the home. This may be when the property is sold, or when the borrower moves to aged care or passes away.
Market Pricing & Fees
After the withdrawal of many participants (including major banks) from the segment, the RM market is now typically the domain of specialist credit providers.
The spread in Interest Rates between a home loan and a RM has pushed out from around 1.5% to around 3% in recent times. This means an interest rate in the 6-7% range with application fees. This premium in rate must also be considered in the light that the average loan amounts are considerably smaller than traditional mortgages.
Borrowers are generally required to seek independent financial and legal advice as part of the process too, which adds another cost to the borrower.
Benefits & Pitfalls
As an initial comment it is obviously critical to get the right advice. Some outcomes for the borrower include:
- Customers can fund home improvements, consolidate debt, upgrade a motor vehicle, etc.
- Allows existing income to be supplemented and improve the quality of retirement.
- Peace of mind to protect against for future needs such as medical expenses.
- Still get the benefit of growth in property value.
Whilst there are benefits, borrowers must be wary of the growth of their loan balance when interest is capitalised. This obviously can defray the available equity in their home.
Comparison with "Equity Share" products
This is typically a contract to sell a share of the future sale proceeds of your home. In exchange for selling this share, an upfront amount is paid to the home owner.
The amount advanced depends on the owner's age and the value of the home today, and of course how much of the future share you wish to sell. In terms of eligibility, the other terms are similar to a reverse mortgage.
In assessing the benefits of these products to a reverse mortgage, well it largely comes down to your long term of the property market.
If you think that property growth will be less than the interest on a Reverse Mortgage, then an Equity Release product might be an attractive proposition for you, the reverse of course applies.
Reverse Mortgage Example:
ASIC have some great resources on their website including a calculator below. Consider an example:
John & Sandra are both 67 years old. Their home is currently unencumbered and is valued at $1,000,000.
They seek a lump sum advance of $250,000 (Representing a LVR of 25%) with the following terms:
8.50% Average Interest Rate (Applying a Buffer to the current rate)
Projected Capital Growth of 2.0% per annum
If this facility pushed out for 15 years (to age 82), with no loan repayments their financial position would have the following profile:
Projected Home Value: $1,345,868
Owe to Lender: $890,663
Net Home Equity: $455,205
Loan to Value Ratio: 66.17%
The example is a reminder that good planning and forecasting is necessary should you access one of these products.
Source: www.moneysmart.gov.au/tools-and-resources/calculators-and-apps/reverse-mortgage-calculator
Want more information. Please contact Martin Bedford in our Melbourne office:
E: m.bedford@mcpgroup.com.au
P: (03) 9620 2001
W: www.mcpfinancial.com.au