What is a reverse mortgage?
Many people in retirement find themselves “asset rich” and “cash poor.” In other words, while they own their home, they do not have sufficient income to maintain the lifestyle that they desire. A reverse mortgage allows those in retirement to borrow a lump sum of money, using their home as security, and to use this lump sum to generate a cashflow to improve their lifestyle.
A reverse mortgage differs from a normal mortgage in one important respect. You are not required to make any regular repayments on a reverse mortgage. The interest on the amount you borrow, as well as fees and charges, are “capitalised” on the loan. This means that over time the amount owing on the loan will gradually increase.

What does it mean to capitalise interest?
The best way to understand capitalisation of interest is to compare with how a normal mortgage operates. In a normal mortgage, you borrow money and repayments are calculated so that the loan is repaid over a set period of time – generally a maximum of 25 years. As repayments are made, the amount owing on the mortgage decreases, and the amount of interest charged decreases. This process is best summarised in the following table. This illustrates what happens to $50,000 borrowed over 15 years at a constant interest rate of 9% pa. The monthly repayment on this loan is $507.13.

With a reverse mortgage, you are not required to make repayments, however interest is still charged. This means that interest is added to the loan on a monthly basis. Over time, interest is charged against the interest that is being added to the loan, causing the amount owing on the mortgage to increase over time. The following table illustrates what happens when $50,000 is borrowed against a reverse mortgage at a 9% pa interest.

How is a reverse mortgage repaid?
The amount owing on a reverse mortgage is repaid when the house is sold, or through the sale of the house upon the death of all the borrowers. From the proceeds of the sale, the lending institution receives the amount required to repay the reverse mortgage.

What are the advantages of a reverse mortgage?
Reverse mortgages are ideal for those that require additional funds to maintain their desired lifestyle, but whose wealth is largely tied up in their home. Many people faced with a lack of cashflow later in life chose to sell their home, and “downsize” to a less expensive property, and use any residue funds to invest. However, for many people selling their home may not be an option. The home may hold great sentimental value, they may enjoy living in their present location, or they may wish to remain close to family and friends. By accessing the wealth in a home through a reverse mortgage, you are able to remain in your home and still invest money to generate a cashflow. Because repayment of loan is deferred, all of the money from the amount borrowed is available to meet lifestyle expenses.

What are the disadvantages of a reverse mortgage
It is very important to remember that the loan amount will gradually increase with a reverse mortgage and this will affect the amount of money available when the house is eventually sold. It is important to inform your loved ones of your decision to take out a reverse mortgage, as the beneficiaries of your Estate can be affected by this type of loan. The amount that will be available upon the eventual sale of your home will depend on many factors including the amount borrowed, interest rates over time, how much the house grows in value, and when the house is actually sold. If interest rates increase over time, and the house is not sold for a long period of time, the equity in the home maybe reduced considerably.

What should I do with the money from a reverse mortgage?
Upon receiving the proceeds of a reverse mortgage you are faced with the important decision of how these funds should be allocated. As a reverse mortgage is primarily designed to access funds to improve your lifestyle it is critical that you consult a financial planner that will be able to advise you of your options. This may include spending a lump sum on a long anticipated holiday (for example), as well as investing some to supplement your regular lifestyle expenses. The manner in which money is spent or invested may affect your tax and Centrelink position, and professional advice will help you be aware of the implications as well as the options available to you.