The trendy reverse mortgage: You’re safer than ever!
Do you associate reverse mortgages and home release with the thought that older Australians have debts that they can’t repay? Are you losing your home? Are your families forced to sort out a legal mess after their deaths?
Reverse mortgages have been available in Australia since the early 1990s and for a long time they have been poorly designed and user results have not been prioritized. The reverse mortgages offered by a handful of banks and other financial services companies of the time tended to have high interest rates and opaque fee structures. Consumers have been burdened with excessive interruption costs to prematurely end the mortgage. At the time, reverse mortgages were loosely regulated by government regulations, leaving consumers exposed to predatory sales practices and poorly designed products.
However, things have changed fundamentally. Following the introduction of the National Consumer Credit Legislation Amendment (Enhancements) Act 2012, reverse mortgage lending is now federally regulated and is one of the most strictly regulated credit products in Australia with clear consumer protection rules that apply throughout the life of the loan.
Since these changes were introduced, most traditional reverse mortgage providers have left the market and paved the way for new providers like Household Capital. Not only are the newcomers not carrying the “baggage” of a history of misaligned products that have been inappropriately sold, but they also adhere to responsible lending requirements and actively work to improve retirement results for their customers. Even the federal government has expanded its offering of home equity investments by opening Centrelink’s retirement loan program to all Australians of retirement age.
But … memories of the old reverse mortgage market have lingered, meaning some senior Australians are missing out on the opportunity to significantly improve their long-term retirement funding.
A reverse mortgage does not sell any part of your home
Before we explain how reverse mortgages have changed for the better, we need to explain one important difference; a reverse mortgage is not the same as a homecoming program.
In simple terms, a home reversion program involves buying part of your home at a discount to its current value. The upside is that you get paid for the part of the house you sell, so you get access to funds without having to sell your house and move out. You don’t have to make any repayments as the company that offers the home revision program will get their money back if your home is eventually sold.
The downside is that the discount on your home’s market value can be up to 75 percent or more, depending on your age and other factors.
For example, if your property is worth $ 500,000 in today’s market and you have access to 25 percent of that through a home revision program, that portion of your property is theoretically worth $ 125,000. But the company offering the program may offer you 25 percent or less of that value in exchange for taking a 25 percent stake … so only $ 31,250.
However, when it comes to selling your home, the company offering the program receives 100 percent of the capital gain made on the portion of your property it acquires. So if your home goes from $ 500,000 to $ 750,000 on the sale, that company will get 25 percent of the $ 750,000 – $ 175,500 – in exchange for their initial payment to you of $ 31,250. That’s quite a win!
In a nutshell, the story of reverse mortgages
A reverse mortgage is a loan that is secured on your home just like a normal mortgage. The difference is that a mortgage lender will advance you a lump sum to buy a property, while a reverse mortgage lender will convert some of the equity built in your property into a lump sum, a source of income – or both.
With a mortgage, you have to repay the principal with interest so that the lender can repay the money you borrowed. A reverse mortgage does not require principal or interest payments as the lender knows that their loan is already covered by the equity of your property. The property doesn’t have to increase in value for you to pay off your loan.
Instead, the interest charges on your reverse mortgage increase, so the size of your loan grows over time (like your home equity normally in line with property prices) until your home is sold and your original loan plus accrued interest is repaid.
Principal repayments and / or interest payments during the life of a reverse mortgage slow the growth of the loan, which is why Household Capital allows borrowers using their household loan to repay on demand or in full their loan at any time with no penalty.
Why reverse mortgages are safer than ever
Not only can you retain full ownership of your home with a reverse mortgage, but there are other consumer safety nets built into consumer credit legislation. This includes guaranteed lifetime use and a non-negative equity guarantee. How do these guarantees work?
According to the law, the amount of your total loan cannot exceed the value of your home. In other words, you – or your estate – will never be left with debt after your home is sold. This is the non-negative equity guarantee.
To ensure your loan doesn’t get disproportionately large compared to the value of your property, the Australian Securities and Investments Commission (ASIC) has strict caps on the amount of equity you can access. This cap goes into the LTV (or LVR), a calculation based on your age and the value of your property to determine the dollar value of home equity that you can access. The older you are, the greater the proportion of equity that is available to you.