Reverse mortgage and home equity release

If you’re aged 60 or over, own your home and need to access money, releasing equity from your home may be an option.

There is risk involved and a long-term financial impact. Get independent financial or legal advice before you go ahead.

How home equity release works

‘Equity’ is the value of your home, less any money you owe on it (on your mortgage).

‘Home equity release’ lets you access some of your equity, while you continue to live in your home. For example, you may want money for home modifications, medical expenses or to help with living costs.

Ways to access equity in your home include:

• reverse mortgage

• home reversion

• equity release agreement

• the Government’s Pension Loans Scheme

The amount of money you can get depends on:

• your age

• the value of your home

• the type of equity release

Your decision could affect your partner, family and anyone you live with. So take your time to talk it through, get independent advice and make sure you understand what you’re signing up for.

Get independent advice

Before making the decision to apply for any home equity release, consider how it will affect:

• your eligibility for the Age Pension

• your ability to afford aged care

• your ability to pay for future living expenses, medical bills and home maintenance

• what you leave for others when you die

• if someone lives with you, whether they will be able to stay in your home when you move out or die

If you are borrowing to invest, it puts your whole home at risk — not just the portion you are investing.

Ask the Services Australia Financial Information Service how it will affect your pension or government benefits.

Reverse mortgage

A reverse mortgage allows you to borrow money using the equity in your home as security.

If you’re aged 60, the most you can borrow is likely to be 15–20% of the value of your home. As a guide, add 1% for each year over 60. So, at 65, the most you can borrow will be about 20–25%. The minimum you can borrow varies, but is typically about $10,000.

Depending on your age and lender policy, you can take the amount you borrow as a:

• regular income stream

• line of credit

• lump sum, or

• combination of these

How a reverse mortgage works

You stay in your home and don’t have to make repayments while living there. Interest charged on the loan compounds over time, so it gets bigger and adds to the amount you borrow. The interest rate is likely to be higher than on a standard home loan.

You repay the loan in full, including interest and fees, when you or your deceased estate sell your home.

You may be able to make voluntary repayments earlier, if you wish. You may also be able to protect a portion of your home equity from being eroded by the loan. For example, to ensure you have enough money left to pay for aged care.

What a reverse mortgage costs

The cost of the loan depends on:

• how much you borrow

• how you take the amount you borrow (for example, a lump sum will cost more due to compounding interest)

• the interest rate and fees (for example, loan establishment, ongoing fees, valuation)

• how long you have the loan

Over time, your debt will grow and your equity will decrease (see our case study below).

Your lender or broker must go through reverse mortgage projections with you, showing the impact on your home equity over time. Get a copy of this to take away, and discuss it with your adviser. Ask questions if there’s anything you’re not sure about.

Negative equity protection

Reverse mortgages taken out from 18 September 2012 have negative equity protection. This means you can’t end up owing the lender more than your home is worth (market value or equity).

If you took out a reverse mortgage before this date, check your contract. If it doesn’t include negative equity protection, talk to your lender or get independent advice on what to do.

Home reversion

Home reversion allows you to sell a proportion (a ‘share’ or ‘transfer’) of the future value of your home while you live there. You get a lump sum, and keep the remaining proportion of your home equity.

How home reversion works

The home reversion provider pays you a reduced (‘discounted’) amount for the share you sell. Depending on your age, this may be 25% or more of the current value of the share.

Terms and conditions vary. The provider may offer a ‘rebate’ feature. This means you (or your estate) get some money back if you sell your home (or die) earlier than expected. You may also have the option to buy back the sold share later, if you wish.

For example, suppose your home is currently worth $500,000 and you sell a 20% ($100,000) share of the future value. The provider may only offer you $25,000 to $40,000 to buy that share. When you sell your home, you pay the provider their share of the proceeds. So, if in 20 years time you sell your home for $800,000, the provider gets 20% of that amount: $160,000.

What home reversion costs

It’s not a loan, so you don’t pay interest. You pay a fee for the transaction and to get your home valued (as a guide, around $2,000). You may also have to pay other property transaction costs.

Home reversion costs you the difference between:

• what you get for the share of your home you sell now, and

• what it’s worth in the future (minus any early sale rebate)

The more your home goes up in value, the more you’ll pay the provider when you sell it.

Get the provider to go through projections with you, showing the impact over time. Get a copy of this to take away, and discuss it with your adviser. Ask questions if there’s anything you’re not sure about.

Equity release agreement

An equity release agreement allows you to sell a portion of the value of your home. You get a lump sum or instalment payments in return. You live in your home and pay fees for the portion you’ve sold. A bit like paying rent on it. Your proportion of equity reduces over time, to cover the fees you pay.

How an equity release agreement works

One option is for one or more investors to buy portions of your home’s equity through a property investment fund. You pay fees which are periodically deducted from the remaining equity in your home. The investor’s share of your home’s equity goes up over time, and yours goes down.

For example, suppose your home is currently worth $500,000. You sell 20% of your home’s equity in return for a lump sum of $100,000. The fee charged by the fund may vary, depending on your circumstances and the agreement. If the fund charges an initial fee of $30,000, it may take $130,000 of your equity to cover both the lump sum and periodic fee.

Additional amounts of equity are deducted each time the periodic fee falls due (such as every 5 years). The fee is a set percentage of the fund’s equity in your home. So, as the fund’s share of equity increases, the fee goes up.

When the equity release agreement ends, and your home is sold, the fund gets their share of the proceeds. That is, the proportion of your home’s equity they have accrued. You or your deceased estate get the remainder of the proceeds, if any.

The proportion of home equity you keep will reduce over time, and could even go down to zero.

Check your agreement to see what happens if your equity goes down to zero. Make sure you can continue living in your home, until sold by you or your deceased estate.

What an equity release agreement costs

It’s not a loan, so you don’t pay interest. Instead, you pay fees such as:

• an application fee

• periodic service fees, potentially deducted in advance from your home’s equity

• a fee to end the agreement

Get the fund to go through projections with you, showing the impact on your home equity over time. Get a copy of this to take away, and discuss it with your adviser. Ask questions if there’s anything you’re not sure about.

Pension Loans Scheme

The Pension Loans Scheme is provided by Services Australia and the Department of Veterans’ Affairs. It lets eligible older Australians get a voluntary non-taxable fortnightly loan from the Government. You and your partner may use this to supplement your retirement income.

You can choose the amount of loan you get paid fortnightly. Your combined pension and loan payments cannot exceed 1.5 times the maximum fortnightly pension rate.

The loan is secured against real estate you, or your partner, own in Australia. You can choose how much you offer as security.

There is a maximum amount of loan you can borrow over time. This is based on your (or your partner’s) age and how much you offer as security for the loan. The Pension Loans Scheme is not paid as a lump sum.

You must repay the loan and all costs and accrued interest to the Government. You can make repayments or stop your loan payments at any time.

For more information about the Pension Loans Scheme, visit Services Australia or the Department of Veterans’ Affairs.

Consider other options

If you need money, other options to consider include:

• Government benefits — Check if you’re eligible for the Age Pension or government benefits.

• No or low interest loan — Lets you borrow a small amount of money quickly for essential goods or car repairs. There are no fees.

• Downsizing — If you’re thinking about selling your home and downsizing, consider the cost of buying and selling. Check if it affects your government benefits.

• Other support — If you’re struggling to make ends meet, see urgent help with money for free services that can help.

Case Study 

Lorenzo and Sophia consider getting a reverse mortgage

Lorenzo is 70, Sophia is 65 and their home is worth $500,000. They want to renovate, but don’t have enough savings.

They use the reverse mortgage calculator to explore what a loan might cost. Based on Sophia’s age, the most they can borrow is 25% of the value of their home: $125,000. They want a lump sum to pay for the renovations.

They allow $1,000 for loan set-up fees and use the default interest rate of 7%.

In 15 years, if their property goes up in value 3% each year, it will be worth $779,984. They will own 54% of their home ($420,016), and owe the lender 46% ($358,967).

They decide to get financial advice and consider borrowing a smaller amount.

Call us on 02 9553 9293 if you would like more information on reverse mortgages. 

Source: moneysmart.gov.au
Reproduced with the permission of ASIC’s MoneySmart Team. This article was originally published at https://moneysmart.gov.au/retirement-income/reverse-mortgage-and-home-equity-release

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