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How do reverse mortgages work?

My Mum has a nice house but is really, as they say, asset rich but cash poor. She is close to 70 and has no super and my brothers and sisters, well most of them, want her to sell the place and live comfortably. One of my brothers thinks a reverse mortgage might be an alternative. What do you think about these and could you explain it in simple language?

A reverse mortgage permits your Mum to borrow money using the equity in her home as security. How much a lender will lend will often depend on her age and the property’s value. She could receive the funds as a lump sum, regular payments or a mixture of both.

The loan, interest and any other fees or charges are repaid only when your house is sold and that’s a big appeal.

Note, because this sounds like a good deal the interest rates are usually higher for reverse mortgages and any fees uncharged upfront will come back in some form when the house is sold, say after a death or a voluntary sale.

There are different kinds of reverse mortgages so read all of the fine print and compare the different loans out there.

Make sure that the loan has a 'no negative equity guarantee' clause. This protects you and your beneficiaries if your loan does become greater than the realised value of your property.

Also the fees are added to your loan so you'll pay more in interest in the long run, so some people pay them upfront, but it's rare, and watch out for any tricky other fees that could make the loan more expensive than it looks.

Go through a whole lot of “what ifs?” to see what happens, say if your Mum wants to sell the house, go into a retirement home, or if she should pass away. Go into the deal with your eyes wide open and look for penalty clauses.

Also see how your Mum’s government entitlements would be affected by the loan. That’s important and Centrelink is the place to check that out.

I think you should get some expert advice, even if you have to pay for it. I worry about reverse mortgages when a house is not very valuable and the borrowing is quite high.

A perfect case might be a house worth $1 million and the borrowing is $200,000. And say if the interest rate and other costs were 9 per cent but house prices rise on average in your Mum’s suburb by 10 per cent then the house is gaining $100,000 a year but the cost of the loan is only $18,000.

Of course the borrower does not pay this amount until they leave the property. The example demonstrates that capital gain can offset the potential cost of a reverse mortgage but if the value of the home is low and the capital gain is low, the cost of the deal could be prohibitive.

Good luck with it and as I recommend — do lots of homework and get expert advice, even if you have to pay for it. The adviser might even have a better idea and that’s worth paying for.

*Update: cost of loan corrected and clarification added.

For advice you can trust book a complimentary first appointment with Switzer Financial Services today.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice. 

Published on: Wednesday, April 28, 2010

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