Reverse mortgages

A reverse mortgage can help fund your retirement. CHOICE outlines the risks.
 
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01 .Introduction

Toy house

Reverse mortgages target homeowners aged 60 and older who want to borrow money against the value of their property.

The advantage of a reverse mortgage is that you don't need to make repayments on the loan until you move, sell or die. However you should be aware that it may restrict the flexibility of your financial arrangements.

Findings

  • While the majority of reverse mortgage products have improved their consumer protection standards there are still traps with most of them.
  • Some customers have missed out on interest rate cuts or loan top-ups because their provider no longer writes reverse mortgages.
  • Some financial institutions have responded to the global credit crisis by suspending their reverse mortgage products. 
  • Step-by-step guide explains how a reverse mortgage works, features to look for and pitfalls.
  • Checklist: What to consider and questions to ask.

CHOICE reverse mortgage standards

Reverse mortgages have come a long way since CHOICE first looked at them in 2004. In 2007 we developed contract standards for reverse mortgages; none of the providers we surveyed then met all these standards. In 2009 (when this report was first filed), all participating providers met the five CHOICE minimum contract standards, but only four met the CHOICE good-practice standard. Two providers, Transcomm and HomeStart, did not participate in the 2009, and based on publicly available information and information we collected from them in 2008, they continue to miss our minimum contract standards, the main problem being they don't stand by their no negative equity guarantee (NNEG) if the borrower is in default. The NNEG this means is that you can never owe more than the sale proceeds of the property, even if its sale price doesn’t in reality cover the debt.

Minimum contract standards

The no negative equity guarantee (NNEG) applies even if you're in default of the contract.
No fixed loan term - the borrower can repay the loan at any time. But unless you're in default of the contract, the lender can only request repayment when the house is sold, you move into long-term aged care or you die.
The lender can't ask you for partial repayments during the course of the loan.
You must get independent legal advice before signing.
The mortgage company and the lender participate in an ASIC-approved dispute resolution scheme.

Good-practice standard

This standard requires that default conditions are clearly defined and the contract does not include any condition that puts you in the danger of default for breaching a minor, unspecified clause in the terms and conditions or contract. Some providers' contracts and terms and conditions are complicated and at times difficult to understand, which could lead to catastrophic consequences if failure to adhere to a minor clause is considered a default condition. If you're in default, the lender can potentially force you out of your home and sell it.

 
 

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  • The amount you can borrow is dependent on the lender's loan-to-value ratio (LVR). This generally ranges from 10% of the home's value for someone aged 60, to as much as 40% for someone aged 80 (such as $50,000 to $200,000 for a house worth $500,000).
  • Usually no repayments are necessary until you sell the house, move out permanently or die.
  • If your home is owned jointly with a partner the loan usually must be in both names, and is only repayable when the last surviving partner dies or moves. If only one partner of a couple owns the house or a family member lives with you, a reverse mortgage may not be suitable, as it normally becomes repayable when the borrower moves out permanently or dies. However, some contracts protect the right of a resident who isn’t the borrower to stay in the house after all borrowers have died — if this is what you need, make sure you find a lender whose contract covers it.
  • You can access the proceeds of a reverse mortgage as a lump sum, regular amounts (such as monthly), a combination of both or flexible drawdowns (different amounts can be drawn down over time as you need them). Some companies also offer a cash reserve facility, where you can store extra funds without paying interest if you don’t use them. Not all lenders offer all options and there can be fees per drawdown. If you decide on regular payments or flexible drawdowns, check the conditions under which the lender can stop payments.
  • Interest rates: generally the interest rate is variable, but some lenders offer fixed rates either for a set number of years or your lifetime. Fixing the interest rate gives you a sense of certainty, however, a lender may apply expensive fees (called ‘break costs’) if you pay off the loan before the end of a fixed-rate period. Check whether the break costs also apply if you need to move into long-term aged care or die.
  • With a reverse mortgage the title of the home stays in your name and you’re responsible for all ongoing costs, such as rates and maintenance.

National Information Centre on Retirement Investments (NICRI)

In February 2009, the National Information Centre on Retirement Investments (NICRI) launched a telephone service providing independent information on equity release products such as reverse mortgages. Within four months its Equity Release Reverse Mortgage Information Service (ERRMIS) had answered more than 3000 calls. Some have been from consumers who have a reverse mortgage with lenders that have left the market. Some customers have been refused mortgage top-ups, which means they have to look at switching to another lender and paying set-up costs such as fees for loan establishment, valuation and independent legal advice a second time.

In the worst case, customers are locked into a fixed-interest rate product, as leaving the lender would mean incurring a break fee of tens of thousands of dollars (see Broken by the break fee). Volatile interest rates in the past year have highlighted the potential risks of fixing the rate.

A reverse mortgage is a long-term commitment you usually keep for the rest of your life. You should take the following into consideration before you sign up to one:

  • Is a reverse mortgage the best option? Could you downsize instead? Will a reverse mortgage affect your eligibility for a pension? To make sure your pension won't be adversely affected, contact the Centrelink Financial Information Services.
  • Talk to your family A reverse mortgage will make a big difference to any inheritance. Could your children help out instead?
  • Consider your possible future needs. Should you need an aged-care accommodation bond, will you still have enough money? Contact the Department of Health and Ageing for information on aged care.
  • Compare loans and features: Which is the best reverse mortgage for you? Do you want regular payments, a cash reserve facility or a lump sum? How flexible is the contract - can you keep your home for a time if you move into aged-care accommodation? Do you want a variable or fixed rate? Compare interest rates, fees and break and exit costs. Even though the lender will own an increasing proportion of your home, remember you'll have to pay for looking after it.
  • Can the lender ask you for a repayment before you die or move out permanently?
  • Compare scenarios Calculate a range of loan amounts, interest rates (including compound) and changes in house value over time, taking your life expectancy into account. There are free calculators at fido - the Australian Securities & Investments Commission's (ASIC) consumer website - and ERRMIS' website.
  • Check the contract and default clauses Are they in plain English or are they hard to understand - would you be in default if you forgot to fill out an annual declaration or broke any of a long list of contract clauses?
  • Can permanent residents who aren't co-owners stay in the home if you die?
  • Disputes Make sure the lender and anyone you deal with (such as the mortgage broker or company managing the mortgage) are all members of an approved dispute resolution scheme. To check, contact the Financial Ombudsman Service or ERRMIS.
  • Get independent legal and financial advice For free information on how to do so, contact ERRMIS.

Reverse mortgage as a last resort 

If you do decide on a reverse mortgage: 

  • Plan for the long term If you take out a reverse mortgage at a relatively young age, the loan will increase over the long term and reduce your options. 
  • Delay taking out a reverse mortgage as long as you can and only take what you really need Taking smaller amounts over a period of time rather than a lump sum will reduce the interest you pay.
  • Understand the downside of fixing your rate Although this gives you greater certainty about future costs, break fees can apply if you want to switch, especially if interest rates fall. 
  • Plan your exit strategy Keep track of your financial situation so you don't miss out on selling your home, repaying the loan and still having enough money left to do what you want to do.

More info

Help us help you

Occasionally we receive calls from journalists looking for case studies. If you’re interested please send an email with your experiences to money@choice.com.au and include a daytime phone number. We'll always contact you first asking for your agreement before giving your contact details to journalists.

Talk it over 

CHOICE member Edward, from NSW, took out a reverse mortgage three years ago when he found out he was seriously ill. He gave each of his children some money from the reverse mortgage and he can still draw down if he needs more money in the future.

Edward spoke to a number of people before making the decision, including the association of reverse mortgage lenders SEQUAL, a financial planner, family and friends.

In the end he chose a provider that does not have any ongoing fees, and he is currently on a variable rate product. Edward thinks the process was "fairly easy and the bank was upfront about everything".

Broken by the break fee

Rick from SA told us his stepmother, Helen, took out a reverse mortgage with Bluestone 18 months ago to give her older children their inheritance well ahead of her death.

She took a lump sum of $160,000 and locked into a lifetime fixed interest rate of 8.89%. The mortgage subsequently grew to $189,000.

Helen recently downsized to another property. She was asked to repay more than $40,000 to switch her mortgage to the new house, which is valued less than her original home.

To their amazement, they found out that if Helen had chosen to try repaying the whole reverse mortgage instead, she would have been charged a break fee of more than $100,000 in addition to the debt she owes.

We contacted Bluestone, who said that because Australia has seen unusually low interest rates lately, break costs have been quite high. Bluestone said under other circumstances it may pay clients a break profit.

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