Reverse mortgages allow a new class of home owners to borrow money against the value of their home. Asset-rich, cash-poor retirees are taking out reverse mortgages in record numbers.
A recent study showed that in 2006 the loan book of reverse mortgages in Australia grew 77 percent, from 16,600 to 27,900.
Reverse mortgages are typically available to home owners aged over 60 wanting to supplement their retirement income or take the loan as a lump sum. Borrowers are under no obligation to make regular repayments until they leave their home, move into aged care, sell their home or die.
When one of these events occurs and the loan ends, the borrowers must repay what they owe, usually out of the proceeds of the sale of their home. However, as no repayments are made until one of these events occurs, interest compounds and debt can accumulate quickly.
Retirees looking to borrow funds under a reverse mortgage arrangement must choose their product carefully. A survey by the consumer lobby group Choice in February 2007 found that many mortgage brokers gave poor advice with inadequate product information.
Some contracts also contain unfair clauses which are not explained to borrowers. Brokers promoting the loans did not explain cheaper options and encouraged borrowers to apply for the maximum possible loan.
The following are two case studies of reverse mortgage arrangements given by ASIC:
- A widow takes out a reverse mortgage to supplement her pension, which is her only income. As she gets older, she is entitled to borrow more. When she dies, most of the proceeds from the sale of her house are used to repay her debt, and there is little left for her beneficiaries.
- A pensioner couple take out a reverse mortgage for $80,000 to renovate their bathroom, buy a car and give their daughter $20,000. Their pension is reduced because the car is assessed as an asset and because of the gift to their daughter. Fifteen years later the husband dies. The wife can no longer live independently and needs aged care. After selling the house to pay off the debt, she cannot afford the accommodation she wants.
ASIC has also provided a table demonstrating how a reverse mortgage loan can double in less than 10 years with compound interest. It is based on a 70 year old retiree who borrows $100,000 at an interest rate of 8.32% per year against a $400,000 home.
|
Number of years since taking out the loan
|
Projected value of the home (based on 3.5% increase per annum)
|
Amount estate will owe if interest rate is 8.32%
|
Amount estate will owe if interest rate increases to 11% after the first 2 years then applies throughout |
| 5 years |
$475,000 |
$154,000 |
$167,000 |
| 10 years |
$564,000 |
$234,000 |
$290,000 |
| 15 years |
$670,000 |
$356,000 |
$502,000 |
| 20 years |
$796,000 |
$540,000 |
$869,000 (exceeds value of home - negative equity) |
Many reverse mortgage products stipulate that a borrower will not have to repay more than the value of their home if the loan increases to a point where it is worth more than the value of the property. This is known as a “no negative equity” clause.
However, the Choice study found that 13 out of 23 reverse mortgage loans surveyed contained default clauses where small oversights could result in borrowers losing their “no negative equity” guarantee. Examples included:
- not paying council rates on time, or
- failing to complete a status report on the property at the end of each year.
Through a simple omission, unsuspecting retirees could find themselves without a home and unable to afford aged care accommodation.
Due to the risk involved, it is crucial that borrowers conduct thorough research before taking out a reverse mortgage loan.
Borrowers should seek independent legal and financial advice to ensure that they understand how much they can afford to borrow, how interest accumulates and how the terms of the contract operate.
From a lender’s perspective, there is a risk in reverse mortgages as courts and tribunals will examine the documents and the circumstances surrounding their execution.
Lenders should insist upon certificates of both independent legal and financial advice.
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