Older Australians laid off in the coronavirus pandemic have been left scrambling for income as the economy experiences a once-in-a-generation shock.
With traditional investments yielding smaller dividends and savings rates falling in tandem with historic RBA rate cuts, the temptation to look for alternative financing is high.
But older workers have been warned to consider reverse mortgages as an “absolute last resort”, to avoid disputes over wills and reduced equity later in life.
Instead, financial planners say they should consider lower-risk alternatives like downsizing their home, or gaining early access to their superannuation.
Canstar finance expert Steve Mickenbecker told The New Daily reverse mortgages are an option for cash-strapped retirees who have few savings or assets.
“Reverse mortgages enable retirees with low incomes to access credit that would not otherwise be available, to lift their standard of living or in some other way improve their lives,” Mr Mickenbecker said.
So, what are reverse mortgages?
Fundamentally, reverse mortgages allow home owners to exchange wealth tied up in their home for a loan, which is repaid upon the sale of the property or the borrower’s death.
This is either delivered as a lump sum or smaller recurring payments.
With older Australians decades into paying off their mortgage, taking out a reverse mortgage could free up cash to bolster spending on renovations or medical procedures.
And it grants them access to this money without selling their home.
Unlike traditional mortgages, reverse mortgages are tied to equity, so the criteria for prospective borrowers is different:
- Borrowers need to be at least 60 years old (as repayments can balloon with higher interest rates and no repayment obligations)
- Borrowers do not need to establish they have a steady source of income
- The loan compounds interest charged over the length of its term, which means the loan’s balance increases as interest accumulates. Therefore, loan-to-value ratios are generally capped based on an applicant’s age and size of existing equity.
What are the risks of taking out a reverse mortgage?
A 2018 review by ASIC found borrowers had little knowledge of the risks of reverse mortgaging.
In particular, retirees largely failed to understand the impacts on their longer-term needs – including aged-care costs and their children’s inheritance – if too much equity is eroded by substantial debt.
“Lenders and brokers need to make inquiries that would lead to a genuine conversation with customers … not just a set of tick boxes,” ASIC deputy chair Peter Kell said.
Fitzpatricks Private Wealth certified financial planner Randall Stout told The New Daily although reverse mortgages lessen short-term financial pain, the risks for a borrower’s next of kin are immense.
“The issue with [reverse mortgages] is the interest is capitalised on the loan, so if you start with a small loan, after 15 years you can erode a home’s equity,” Mr Stout said.
“The risk is the children of the borrower could argue they should never have taken out the loan in the first place, because it’s resulted in their inheritance being shaved.
“And if you live with a partner and die with a reverse mortgage, the estate will have to deal with the loan.
“So, if you have a half-a-million dollar house and took out a $80,000 loan, and with interest the loan is now worth $250,000, your partner would have to either repay it or sell the property, so [the loan] doesn’t go away.”
Reverse mortgage rates sit roughly three percentage points higher than traditional home loan rates, but vary between lenders.
With Australia now home to rock-bottom interest rates (after the Reserve Bank indicated it would not drop the official cash rate below 0.25 per cent), reverse mortgage rates have followed suit.
Beyond Today Financial Planning adviser Antoinette Mullins said historically low rates could prompt struggling home owners to take the “easy way out” and sign up for a so-called “buy now pay later-style loan.”
But she said options like downsizing free up equity without the risks of saddling long-term debt.
“If you are selling in the market anywhere between now and 10 to 20 years time, there’s always potential for further falls,” Ms Mullins told The New Daily.
“You have to take into account that the loan doesn’t drop, your equity drops – and if you need that equity to pay for aged care or anything else, you will be in dire straits.”
Ms Mullins added that Australians over the age of 60 also have the capacity to start a tax-free pension using their super fund if they have become unemployed.