A reverse mortgage is a specialised home loan product allowing a borrower to tap into their home equity without having to meet regular repayments. They're typically best suited to homeowners over the age of 60 who are asset rich but cash poor.

Reverse mortgages are popular among retirees and pensioners who want to borrow against their home, which they own outright, but who don't have the income to service a traditional home loan.

See also: Refinancing to access home equity

What is a reverse mortgage?

A reverse mortgage is an equity release product that allows older Australians to borrow money using the equity in their home as security for the loan. The amount of equity that can be released is generally determined by considering the borrower's age and their property's value.

How does a reverse mortgage work?

Rather than being repaid in regular instalments, interest charged on funds borrowed with a reverse mortgage is capitalised – that is, added onto the mortgage's principal balance. The outstanding balance, plus accumulated interest, is repaid when the property is sold, the borrower moves out, or their estate is divided up.

A borrower can often choose to receive funds from their reverse mortgage as a lump sum, a regular income stream, a line of credit, or as a combination of these options.

When you take out a reverse mortgage, you remain the owner of your house and can live in it for as long as you want to. You'll only have to repay the loan (including interest) when you sell your house, move into an aged care home, or pass away. Though, you can usually make voluntary repayments if you wish to.

There are generally no income requirements for reverse mortgages, but responsible lending requirements mean not everyone will be eligible for this type of loan.

How much does it cost to take out a reverse mortgage?

As with most home loan products in the market, reverse mortgages entail various fees. These might include an establishment fee, ongoing admin fees, and discharge fees. However, as with a traditional mortgage, the largest expense will likely be the interest charged on the borrowed funds.

Be aware of compounding interest

Perhaps the biggest cost of reverse mortgages is compound interest.

As interest is added to the loan's principal balance rather than being repaid regularly, a borrower will end up being charged interest on interest, which can cause their debt to grow rapidly. The longer you hold a reverse mortgage, the longer interest will compound, and the larger the sum you or your estate will eventually need to repay.

Interest rates on reverse mortgages are also generally a few percentage points higher than a traditional mortgage, meaning more interest is charged per annum.

Let's assume you own a home worth $500,000 and take out a $100,000 reverse mortgage with a consistent 9.00% p.a. interest rate. Here's how the interest on the reverse mortgage would compound over time if interest was charged monthly:

Year

Annual interest payable

Principal balance owing

1

$9,381

$109,381

2

$10,260

$119,641

3

$11,224

$130,865

4

$12,276

$143,141

5

$13,445

$156,586

10

$21,024

$245,136

15

$32,915

$383,804

20

$51,535

$600,915

That chart might be eye opening, but rest assured the value of the property being mortgaged might also rise over time. Rising property prices have the potential to minimise the impact of compounding interest, as the below chart shows.

However, property prices aren't guaranteed to rise as years go by. In fact, they have been known to crash from time to time, which could have a major impact on a person with a reverse mortgage.

Negative equity protection

But what if, after you take out a reverse mortgage, the housing market falls or your home's value plateaus? Fortunately, you likely won't end up owing your lender more than your house is worth.

Reverse mortgage providers must offer negative equity protection. This protection ensures that if the value of a borrower’s house decreases, they won’t be liable for any debt exceeding the home’s sale price when the reverse mortgage contract ends.

This statutory requirement applies for reverse mortgage contracts lodged after September 2012.

What risks do reverse mortgages present?

Reverse mortgages might be tempting to a retiree who owns their home, but there are risks to consider:

  • Interest rates on reverse mortgages are generally higher than those on standard home loans
  • Debt can grow quickly due to compounding interest
  • Spending funds from a reverse mortgage on deemable assets may affect your pension eligibility
  • You mightn't have enough money for aged care or other future needs
  • If you're the sole owner of a property and someone is living with you, that person may not be able to continue living their if you pass away

For the most part, a homeowner applying for a reverse mortgage will be asked to get independent legal advice before signing on the dotted line.

Reverse mortgage fine print: What to look for

Before you sign a reverse mortgage contract, check the following:

Reverse mortgage information statement

Your credit provider or broker must give you an information sheet that includes details like:

  • How a reverse mortgage works
  • How costs are calculated
  • What to consider before taking out a reverse mortgage
  • Useful contacts for more information

Reverse mortgage projections

Your credit provider is required to explain, in person, how a reverse mortgage could impact your finances over the long term before you proceed. These projections illustrate how a reverse mortgage may affect your home equity over time.

Security

Curious if your lender will accept a holiday home or investment property as security for a reverse mortgage, so your primary residence can remain unmortgaged? Or is your home already mortgaged, leaving you unsure if special arrangements are needed? Be sure to get clear answers to these and any other questions before committing to a reverse mortgage.

Special terms and conditions

Check for any restrictions on how you can use the funds borrowed through a reverse mortgage or on the property used as security.

Life changes

Determine what happens if you need to transfer the reverse mortgage to another property, or if there are implications for your spouse if you pass away. Confirm with the lender if you’ll need permission to sell, lease, vacate, or renovate your house or have someone move in with you.

Non-title-holding residents

If someone resides in the home without an ownership claim, they may be required to move out when the reverse mortgage becomes due. Some reverse mortgage contracts may allow non-title-holding residents to remain in the home after the mortgage holder moves into aged care or passes away.

What is the Home Equity Access Scheme?

The Home Equity Access Scheme (formerly Pension Loans Scheme) offers Australian Government loans to eligible property owners. The loans are offered to Australians of pension age and are designed to supplement a regular, fortnightly income or can be provided as a lump sum.

Like a reverse mortgage, interest charged on the funds borrowed through the Home Equity Access Scheme will compound over time. The borrowed funds, plus accrued interest, will be repaid when the property is sold or recovered from the borrower's estate.

Article originally written by Gerv Tacadena in 2022. Last updated by Brooke Cooper in 2024.

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