17th October 2007
What is a reverse mortgage?
A reverse mortgage is a loan where generally older home owners, who have usually paid off their original home loan, borrow against the value of their house to obtain cash to be used for the likes of overseas travel, improved lifestyle or to pay for grandchildren’s school fees. They do not have to repay the loan until they sell the property, move or die.
So, if you take out a reverse mortgage, you don’t have to make any payments, but each year the fees and interest that you would normally have to pay are added to the loan balance. The outstanding loan balance therefore increases, and over time you are charged interest on the interest (compound interest) and that increases the total amount you owe.
Concerns with reverse mortgages
The interest rate for a reverse mortgage is generally higher than a regular home loan and some borrowers can end up owing more than their house is worth. This is a particular risk if property prices fall – resulting in what is called “negative equity”. Over 15 years, a loan of $50,000 can grow to hundreds of thousands of dollars, so that the equity that you had in your home at the beginning of the reverse mortgage can quickly be eaten away. Some reverse mortgage products guarantee that you will not have to repay more than the value of your home - called a “no negative equity guarantee”. However, you may lose this protection if you do not meet the terms and conditions of the loan – for example, if you don’t repair and maintain your home to a standard set by the lender.
Default clauses in some reverse mortgage loans could also be triggered by simply forgetting to pay council rates.
Loss of equity in your home can affect you in later life, particularly when it comes to having to enter residential care or pay for home care.
Benefits of a reverse mortgage
- You can access cash as a lump sum, a regular income stream or a combination of both;
- You don’t need a current income to qualify;
- You get to stay in your home and keep ownership; and
- You usually don’t have to make any regular repayments while you live in your home.
Reverse mortgage popularity is on the rise
Here are some interesting statistics about reverse mortgages:
Where to apply caution
Like all financial transactions, you should always apply caution.
For example, in ASIC’s review of advertisements for reverse mortgages, ASIC found misleading information such as, loans did not have to be repaid, and reverse mortgages do not affect pension entitlements.
CHOICE, the consumer watchdog, examined 23 reverse mortgage loans against 6 consumer protection standards – none met all six.
Source: The Age, 6 October 2007 & ASIC - Financial Products / Reverse Mortgages
La Trobe's position
La Trobe does not offer reverse mortgages as part of its suite of retail investment products from our Mortgage Fund, as we consider the concerns with regard to reverse mortgages for retail investors currently outweigh the benefits.
Furthermore, for borrowers it is always advisable to seek financial advice from a qualified financial planner or an accountant, as there may be other avenues to obtain funds that you may not be aware of.
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Head of Funds Management
t +61 3 8610 2811
Chris Andrews is the Head of Funds Management for the La Trobe Group and has responsibility for the La Trobe Australian Mortgage Fund.
Read full profile here.
La Trobe is one of Australia's leading independent specialist mortgage Financiers. Its business includes residential mortgages, commercial mortgages, and investment services operating one of Australia's largest Mortgage Funds under AFSL 222213. It employs over 115 staff and has raised over AUD$10Billion to assist over 100,000 customers since inception in 1952.
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