Do you associate reverse mortgages and the release of equity with thoughts of older Australians ending up with debt they can’t repay? Lost their house? Their families forced to solve a legal mess after their deaths?
Reverse mortgages have been available in Australia since the early 1990s and for a long time were poorly designed and user results were not prioritized. Offered by a handful of banks and other financial services companies, reverse mortgages of the era typically came with high interest rates and opaque rate structures. Consumers were faced with excessive cancellation costs for taking out the mortgage early. At the time, reverse mortgages were loosely regulated by state-based regulations, exposing consumers to predatory sales practices and poorly designed products.
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However, things have fundamentally changed. After the introduction of the national Consumer Credit Amendment Act (Enhancements) 2012, reverse mortgage lending is now federally regulated and is one of the most strictly regulated credit products in Australia, with clear consumer protections in place throughout the loan period.
Since these changes were introduced, most traditional reverse mortgage providers have exited the market and paved the way for new providers, such as Household Capital. The newcomers not only carry the “baggage” of a history of misaligned products being sold inappropriately, but also adhere to responsible credit requirements and actively work to improve retirement outcomes for their customers. Even the federal government has expanded its equity offering by opening Centrelink’s pension loan scheme to all Australians who are eligible for retirement age.
But… the memories of the old reverse mortgage market have lingered meaning some older Australians are missing out on an opportunity to significantly improve their long-term retirement financing.
A Reverse Mortgage Doesn’t Sell Part of Your Home
Before we explain how reverse mortgages have changed for the better, let’s explain one essential distinction; a reverse mortgage is not the same as a buy-back arrangement.
Simply put, a home reversion plan involves purchasing a portion of your home at a discount to its current value. The benefit is that you receive payment for the portion of the home you sell, giving you access to funds without having to sell and leave your home. You don’t have to pay back because the company offering the home reversion scheme gets its money back when your home is eventually sold.
The downside is that the discount applied to the market value of your home can be 75 percent or more, depending on your age and other factors.
For example, if your property is worth $500,000 in the current market and you access 25 percent of it using a home remodeling scheme, then that portion of your property is theoretically worth $125,000. But the company offering the arrangement can offer you 25 percent or less of that value in exchange for taking a 25 percent stake…so just $31,250.
However, when it comes to selling your home, the company offering the settlement will receive 100 percent of the capital gain on the portion of your property it purchased. So if your home increases in value from $500,000 to $750,000, on sale that company will receive 25 percent of $750,000 — $175,500 — in exchange for the original payment to you of $31,250. That’s a big win!
Getting the story clear about reverse mortgages
A reverse mortgage is a loan on your home, just like a regular mortgage. The difference is that while a mortgage lender advances you a lump sum that you can use to buy a property, a reverse mortgage provider converts some of the equity built up in your property into a lump sum, a stream of income – or both.
A mortgage requires you to pay off capital with interest so that the lender can get back the money it lent you. A reverse mortgage requires no principal or interest payments because the lender knows that their loan is already backed by the equity in your property. The property does not to have to continue to gain value so that you can pay off your loan.
Instead, the interest charges on your reverse mortgage composition, so the size of your loan grows over time (as usual your equity, in line with real estate prices), until your home is sold and your original loan, plus accrued interest, is repaid.
Paying off capital and/or interest payments over the life of a reverse mortgage will slow the growth of the loan. Household loan to choose to repay if they wish, or to repay their loan at any time without penalty.
Why Reverse Mortgages Are Safer Than Ever
Not only do you retain full ownership of your home with a reverse mortgage, but there are other consumer safety nets built into consumer credit laws. These include a guaranteed lifetime occupation and a non-negative power guarantee. So, how do these guarantees work?
Under the law, the size of your total loan may not exceed the value of your home. In other words, you – or your estate – will never be left with a debt after the sale of your home. This is the non-negative equity guarantee.
To ensure that your loan cannot grow disproportionately large compared to the value of your property, the Australian Securities and Investments Commission (ASIC) sets strict limits on the portion of equity you can access. This limit is factored into the loan-to-value ratio (or LVR), a calculation based on your age and the value of your property, to determine the dollar value of equity that you have access to. The older you are, the greater the portion of equity that is accessible to you.
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