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 regular mortgage top-up every fortnight. There is no requirement to pay any money onto the mortgage and the interest from the debt can also be 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 15% at age 60 moving up to ~35% by age 80. Usually the maximum the lender will allow is 50%.
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?
In this instance, the client would have an in-depth conversation about their financial needs and capabilities. If they were, say, buying a $20,000 car and they have a house worth $1m then it doesn't seem unreasonable. Quite a different discussion if the car was $300,000!
It's important to know that the Reverse Mortgage lenders all have long financial discussions with their clients. They simply don't allow them to withdraw hundreds of thousands of dollars on a whim.
It's understandable that people who don't know all the checks and balances that go into a Reverse Mortgage product are uncomfortable with it. 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. These days, the lenders are required to give an accurate forecast of how the debt will grow and strong discussions around how much money they actually need should be done.
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 post-retirement equity release.
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