Retirees often find themselves in a difficult financial position. Short on income but lots of equity, usually stored in their homes. A typical mortgage top-up won’t work in this scenario. Standard mortgages require income and equity to be assessed and are required to be paid down.
Think of a reverse mortgage as a mortgage top-up every fortnight. There is no requirement to pay any money onto the mortgage and the interest from the debt is also capitalised.
It doesn’t take too much to figure out that this debt could get away on the homeowner without the proper controls. So how do the banks keep this service from getting out of control?
For obvious reasons, banks can’t let reverse mortgages get too high. An 80% loan on the 1st January would sit at around 87% by the end of the year. This is clearly unsustainable for any length of time.
Different banks have different rules but generally, you can borrow a maximum of 5% at age 60 moving up to 50% by age 80.
Consider the scenario of a recently retired 65 year old person with a freehold house, living on Superannuation of approximately $22k per year. Perhaps they need $30k per year income to maintain a comfortable life. This will give them enough money to enjoy their retirement and have the ability to visit the doctor if they need. This scenario doesn’t seem to signal irresponsible lending (or spending). The money is simply locked in an illiquid asset. Reverse Mortgages provide a way to free this up.
That’s a fairly clean example. What about something a little more in the grey area?
Consider a 75 year old that would like to use equity in their home to purchase a car. The car will depreciate and the reverse mortgage will get larger which makes this a double hit on the homeowner. But, maybe the car gives that homeowner significant amounts of additional freedom. Is the debt still bad or is it 50/50?
In all honesty, reverse mortgages make me very uncomfortable. It goes against the rules that Mortgage Advisers adhere to – arranging an affordable mortgage (based on income) that can be paid off as quickly as reasonably possible.
The client must be under no illusion as to what they are signing up for and the costs involved. The banks can give an accurate forecast of how the mortgage will grow and I would want to be sure the client has read it and discussed it with me.
Reverse mortgages fill a specific need in society. If the payment information is clearly conveyed and the reasons for the borrowing are responsible, then they can be considered as a possible option for equity release.
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