From time to time, we are asked to advise our more senior clients on the risks of entering into reverse mortgages. As lawyers who specialise in property law, contractual advice and estate planning, we consider all possible legal aspects of reverse mortgages.
What is a reverse mortgage?
A reverse mortgage is a mortgage that can be taken out against a property, typically your home, when the property is freehold, typically when you are retired and getting on in years, and you are in need of a loan to pay for a renovation, or the purchase of a car, or to fund you for part of your retirement.
Why reverse mortgages?
Unfortunately, with the increase in the cost of living, the inadequacy of the pension and superannuation for the vast majority of Australians, coupled with the fact that we are living longer, this has meant that a growing number of Australians have had to look at different options to fund their retirements, one of which is the reverse mortgage.
On the one hand, reverse mortgages provide a short or medium term solution in that the borrower is able to get a loan which may assist them financially. But, on the other hand, as with all mortgages, they represent a significant legal and financial liability which may continue for many years depending on their life expectancy.
Certainly, the financial institutions which offer reverse mortgages as a lending product require that their customers seek independent legal and financial advice about the terms of the reverse mortgage before they agree to enter into them, which is where we step in.
What we do
When we sit down with our clients who are considering entering into a reverse mortgage, before we advise them as to whether or not it is prudent for them to do so, we take comprehensive notes of:
- their financial and family backgrounds;
- the reasons behind their wish to borrow money (we generally advise against clients entering into reverse mortgages where the benefit is for a third party, for example, a relative and not for themselves);
- the terms of the proposed loan and the security supporting the loan (sometimes security does not need to include one’s own home, for example, an investment property);
- the current status of their estate plan (if they have one and if they do not have one we insist on setting up an estate plan for them); and
- the impact that the reverse mortgage may have on them and their estate plan should the inherent risks involved actually materialise.
Here is a summary of our general advice.
How reverse mortgages work
The loan is secured by a first mortgage against your property and no repayments of the loan are required as is invariably the case with a standard principal and interest loan. This means that that the loan can be taken as a lump sum or more commonly as a line of credit, and less commonly as a regular income stream.
Generally, the maximum you are able to borrow at 60 years of age is between 15% and 20% of the equity or value in your home. This increases by about 1% for every year above the age of 60 years at the inception of the loan, which means the older you are, strangely enough the less risk there is in the eyes of the financial institution and the more you will be able to borrow.
In providing advice to our clients we help them weigh up the risks against the benefits.
The benefits of reverse mortgages are as follow:
- Entering into a properly structured reverse mortgage as part of a properly weighted estate plan is a good way to give you more money in retirement and reduce the size of your estate for the loved ones you leave behind when you die – and thus minimise the potential risk of an inheritance claim being made against your estate. In a lot of circumstances, where family conflict and life expectancy is high, reducing the size of your estate is actually a wise move;
- You do not have to service the loan while you are alive and living in the property (the loan will of course have to be discharged if you decide to sell the property to, for example, downsize into another property or move into a residential care facility) which means more money to use for fixed expenses and other essential expenses;
- Since changes in the law a few years ago as a result of the aftermath of the Global Financial Crisis, which left some Australians “short” whereby the amount they owed banks were more than the value of their homes, it is now no longer legally possible to put yourself in this position in that if you or your executors decide to sell your property, and there is a shortfall, then you or your estate cannot be held liable for the shortfall;
- A reverse mortgage can be taken out for whatever reason and therefore allows you to use the money to, for example, add value to your property by funding an extension on the family home (an extra bedroom, or a “granny flat”) or to discharge other debt (a higher interest personal loan on a car, or a debt due to repaid to a family member) that might otherwise be a liability of your estate in the event of your death;
- Unlike standard principal and interest loans, which enable people to borrow around 80% to 90% of the value of the property, reverse mortgages are invariably for smaller amounts, between 10% to 20%, and therefore the risk is much less.
The risks of reverse mortgages are as follow:
- The interest rate is invariably higher than a standard home loan and the because the debt is not being serviced, the debt compounds which means “interest on interest” is being incurred the longer the loan is in force;
- Taking out a reverse mortgage may affect your eligibility for the pension (which is why it is absolutely essential that you also obtain independent financial advice as well as legal advice before entering into the reverse mortgage);
- Taking out a reverse mortgage say at the age of 65 when you are still active may “bite” later when you get older and need the money to move into aged care which of course is expensive;
- Reverse mortgages sometimes have significant “break fees” associated with early termination, thereby potentially impacting on your equity;
- Significant risks are posed to family members who live with you if you are forced to sell and there is insufficient equity in the property for them to afford to “buy” your interest out by assisting in the discharge of your reverse mortgage loan, which essentially means that family member will be “out on the street” with less money available to buy alternative accomodation.
How we can help
Reverse mortgages will no doubt become an attractive or necessary option for many Australians needing to further fund their retirement. Despite the bad press associated with them following the GFC they are here to stay and we think there will be “products” of this type in the loan market in the future.
It is absolutely critical that if you are considering entering into a reverse mortgage, that you do so in the context of your estate plan.
It is essential that you obtain independent legal advice not only in relation to the risks of entering what is, after all, a significant legal contract, particularly as it is entered late in life, with a undoubtedly powerful corporate institution such as a bank, but what it all means for your future and that of the family you leave behind.
For more information on this topic, or any other issue relating to estate planning, please do not hesitate to call us on 8354 2233 or send us an email at firstname.lastname@example.org. The first telephone call is always free and no obligation.