A reserve mortgage is a loan that can enable an ‘asset rich, cash poor’ older homeowner to access the value held in their property by taking out a loan secured against their home. There are usually no regular repayments on the loan. This means the homeowner will receive capital – i.e., money – and in exchange, they delay payment of the loan until they die, sell the home, or move out of the home (for instance, into a retirement village).
Because there are no regular mortgage payments on a reverse mortgage, the interest is added to the loan balance each month. The rising loan balance can eventually grow to exceed the value of the home, particularly in times of declining home values or if the borrower continues to live in the home for many years. However, the borrower (or the borrower's estate) is generally not required to repay any additional loan balance in excess of the value of the home.
Reverse mortgages haven’t traditionally been very popular in New Zealand, but several facts may be steadily changing that, including:
interest rates are at record lows and look likely to stay that way. This punishes those with money in the bank,
longer life expectancies, which means retirees funds need to last longer than ever,
NZ Superannuation (“the pension”) isn’t enough to fund anything more than a very basic life, and
high NZ house prices have resulted in many retiree’s wealth being tied up in their own home.
A couple of NZ banks now offer reverse mortgages, though there are mixed views (at best!) on their suitability. Overseas, financial market regulators and academics have given mixed views on the reverse mortgage market.
Let’s look at five things that can help you decide whether a reverse mortgage might be right for you.
1. You’ll pay handsomely for it
At the time of writing, the advertised interest rate we checked on a NZ reverse mortgage was over double the advertised interest rate on a one-year fixed home loan for a non-reverse mortgage. The rate is calculated daily or monthly, and because you don't make repayments, the balance you owe will climb quickly! There are application, documentation, valuation, and other fees too.
The rates are higher as the banks must wait 10 to 30+ years before they access the return on their investment.
Keep in mind that interest rates are currently lower than they have been historically. This can have a big impact on a reverse mortgage – as the interest rates applied are all floating. This means they can go up a lot more than their current high (relative to a normal mortgage) levels.
2. You can’t take your house with you, so why not give it to the bank?
Ancient Egyptian Pharaohs tried to take their wealth with them to the afterlife, and graverobbers were the only winners!
Leaving an inheritance appeals to some people, and a reverse mortgage can eliminate that. Despite this, there is a good case to be made for spending your kid’s inheritance (often now called SKI’ing). Most children would rather see their parents enjoy their retirement than concern themselves over leaving something behind – after all, parents usually raise kids to look after themselves.
3. Read the fine print
Reverse mortgages are complex and aren’t right for everyone. They should only be entered into with a full and complete understanding of your obligations as a borrower, which usually includes you being required to keep up with home insurance payments and payment of council rates.
Reverse mortgages have no shortage of conditions and limitations. There are even numerous types of properties that lenders won’t lend against – for example, lifestyle blocks, retirement villages, or homes with a possible leaky building history.
There is plenty of fine print to read through, so legal advice is a must.
4. Reverse mortgages can be dangerous if your circumstances change
For instance, if in years to come there is a need to sell your home to buy a retirement home or enter fulltime rest-home care, reverse mortgages would have probably destroyed the equity in your house. Let’s look an example to explain this:
Susan and Robert take out a $100,000 reverse mortgage at age 65, paying an average interest rate of 8% per year. Their house is valued at $500,000.
At age 80, they decide to sell their home and want to buy a retirement home for $350,000.
By this time, their house has appreciated in value so they can now sell it for $650,000. (After paying real estate agent fees as part of the sale process etc).
However, since they received the $100,000 reverse mortgage, the loan balance has ballooned to around $330,000, and this must be repaid to the bank when their house sells.
Once the bank is repaid, they are left with a remaining sum of $320,000. As the cost of entering the retirement home is $350,000, they have a $30,000 shortfall so are unable to move.
Basically, if your circumstances change many years from now, and you have a reverse mortgage, you could find yourself facing some very tough decisions.
5. Are there other options?
Of course. Other options to release equity in the home include downsizing to a more modest property (and/or one in a cheaper area), moving in with children, or moving into a retirement village. That said, many of these options might not be practical or desirable.
Further options still might include seeking council rates relief, taking on a boarder, selling the home to family, or borrowing from family.
What’s the best alternative?
Naturally, the best alternative to a reverse mortgage is sound retirement planning many years in advance. This needs to be followed through with deliberate steps to ensure an enjoyable retirement free from worries about money.
The bottom line
On paper, reverse mortgages sound attractive. However, they’re expensive, complex, and restrict future choices.
If you’d like to discuss anything mentioned in this article with a financial professional, it would be our pleasure to assist. Please get in touch.