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How does a reverse mortgage work?

You might have heard of something called a ‘reverse mortgage’, which could be one way to access the equity in your home. But there are many considerations to weigh up and it’s important to understand all of the options that might be available to you.

If you’re a homeowner aged 60 and over, a reverse mortgage is one way that you may be able to leverage the equity in your home to access extra cash. This is not something all lenders offer – Westpac doesn’t for instance – but there are other ways to access the equity in your home which may be more suitable for your situation.

 

We’ve broken down the basics of what you need to know below.

 

Reverse mortgages

A reverse mortgage allows you to borrow money from your lender using your home equity as security. 

 

There are a few options for accessing the funds such as a regular income stream, a line of credit, lump sum, or a combination of all.

 

Features of a reverse mortgage

A key feature of a reverse mortgage is that you can stay in your home and won’t have to make repayments to your lender as long as you’re living there. Once you or your estate sells the property though, the reverse mortgage loan will need to be repaid to the lender in full. 

 

The interest charged on the loan will compound over time. Even though you won’t have to repay the loan as long as you’re in the house, interest is still compounding during this period. When the time comes to sell, you or your estate will have to repay this interest in addition to the loan balance you borrowed.

 

Reverse mortgages allow you to borrow more as you age. Each year, the proportion of your home’s value that you can borrow increases. As a general example, if you're 60 years old, you may only be able to borrow 15–20% of the value of your home. This might then be increased by 1% for each year over 60.

 

With that in mind, a reverse mortgage is generally not an option for younger homeowners.

 

To give you a better idea of your borrowing ability and the impact a loan will have on your equity over time, you can use ASIC’s Moneysmart reverse mortgage calculator.

 

Considerations of a reverse mortgage

It's important to weigh up how reverse mortgages could affect your financial situation.

 

While you won’t need to make repayments when still living in your home, once the property used to secure the loan is sold, the reverse mortgage loan balance will need to be repaid in full, including interest and any ongoing fees. 

 

It’s worth keeping in mind that reverse mortgages tap into an important source of wealth (your home), so you need to carefully weigh up the pros and cons and consider your current and future circumstances. 

 

If you’re in life’s later stages, it could also affect your eligibility for the Age Pension. It would also help to speak with a suitably qualified financial or tax adviser to understand the consequences for your personal circumstances.

 

Additionally, it’s worth thinking about anyone who lives with you and what their position will be if you pass away, considering your home is often your biggest asset to be left to others.

 

Negative equity protection

An important recent feature of reverse mortgages is negative equity protection.

 

If you took out a reverse mortgage after 18 September 2012 or plan to in the future, you will be protected by the no negative equity guarantee. This means that you won’t end up owing the lender more than your home is worth if the value of the home you used to secure the loan falls below the value of your outstanding balance.

 

Remember to check your contract if you took out a reverse mortgage before this date. If it doesn’t include negative equity protection, it's a good idea to talk to your lender or get independent advice.

 

How else can I access the equity in my home?

A reverse mortgage is just one way of accessing the equity in your home. Depending on your financial and personal circumstances, alternative options such as loan increases or home reversion may be better suited and are worth considering for homeowners and borrowers at all life stages. 

 

Loan increases

Another way to leverage your home equity is to borrow money through a home loan top up or increase. You’ll need to apply with your lender to increase your existing home loan limit to access the extra cash.

 

A home loan top up or increase is dependent on a number of factors. Firstly, check with your lender if this option is available for your loan type. 

 

You will also need to be in a position to make extra repayments, as by increasing the amount you owe on your home loan, your repayments will also increase. 

 

Additionally, your lender may require a formal valuation to determine the current market value of your home. This is done in order to calculate how much usable equity is in your property. You can get an indication of the value of the property by talking to a local real estate agent or accessing an online estimator like Westpac’s Equity Calculator.

 

If you don’t want to use your equity to increase your current home loan balance, another option is using it to set up a new, supplementary loan account.

 

This may allow you to choose different features from those on your current home loan. For example, a new repayment frequency,  type of interest rate (such as fixed rate) and loan term.

 

Home reversion

Home reversion is when you sell a proportion of the future equity in your home at a discount while continuing to live there in exchange for a lump sum payment.

 

The cost to you is the difference between what you get for the share of your home now and what that share may be worth in the future when you decide to sell. 

 

This can be risky as costs are entirely dependent on the state of the housing market when the sale goes through which is challenging to predict. It’s really important to get independent advice on any future projections and understand the potential impact on your financial situation to weigh up whether this option is right for you.

 

You won’t have to pay interest on the lump sum as it isn’t a loan. However, you will pay a fee for the transaction, to get your home valued, and you may also have to pay additional property transaction costs.

 

With a number of ways to access the equity in your home, it’s important to consider which option is best for your situation and what’s available with your lender. 

 

Westpac doesn’t offer reverse mortgages or home reversion, but we can help existing customers use their equity with a loan increase. However, before making your decision, it may be a good idea to seek independent advice on the best way to unlock equity in your home.

 

Have more questions? Call us on 131 900, to learn more about equity in your home or visit any branch across Australia to talk to your local Home Finance Manager.

Tools and resources

Use equity to renovate your home

You may be able to fund your renovating dreams with a home loan increase, but there are a few things you should think about first.

How to use equity to invest in the share market

You could use your equity enter the stock market and invest in things like individual stocks, managed funds and exchange-traded funds (ETFs).

Things you should know

This information is general in nature and has been prepared without taking your objectives, needs and overall financial situation into account. For this reason, you should consider the appropriateness of the information to your own circumstances and, if necessary, seek appropriate professional advice. Credit provided Westpac Banking Corporation ABN 33 007 457 141 AFSL and Australian credit licence 233714.